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FTC Commissioner Josh Wright is on a roll. A couple of days before his excellent Ardagh/Saint Gobain dissent addressing merger efficiencies, Wright delivered a terrific speech on minimum resale price maintenance (RPM). The speech, delivered in London to the British Institute of International and Comparative Law, signaled that Wright will seek to correct the FTC’s early post-Leegin mistakes on RPM and will push for the sort of structured rule of reason that is most likely to benefit consumers.

Wright began by acknowledging that minimum RPM is, from a competitive standpoint, a mixed bag. Under certain (rarely existent) circumstances, RPM may occasion anticompetitive harm by facilitating dealer or manufacturer collusion or by acting as an exclusionary device for a dominant manufacturer or retailer. Under more commonly existing sets of circumstances, however, RPM may enhance interbrand competition by reducing dealer free-riding, facilitating the entry of new brands, or encouraging optimal production of output-enhancing dealer services that are not susceptible to free-riding.

Because instances of minimum RPM may be good or bad, liability rules may err in two directions. Overly lenient rules may fail to condemn output-reducing instances of RPM, but overly strict rules will prevent uses of RPM that would benefit consumers by enhancing distributional efficiency. Efforts to tailor a liability rule so that it makes fewer errors (i.e., produces fewer false acquittals or false convictions) will create complexity that makes the rule more difficult for business planners and courts to apply. An optimal liability rule, then, should minimize the sum of “error costs” (social losses from expected false acquittals and false convictions) and “decision costs” (costs of applying the rule).

Crafting such a rule requires judgments about (1) whether RPM is more likely to occasion harmful or beneficial effects, and (2) the magnitude of expected harms or benefits. If most instances of RPM are likely to be harmful, the harm resulting from an instance of RPM is likely to be great, and the foregone efficiencies from false convictions are likely to be minor, then the liability rule should tend toward condemnation – i.e., should be “plaintiff-friendly.” On the other hand, if most instances of RPM are likely to be beneficial, the magnitude of expected benefit is significant, and the social losses from false acquittals are likely small, then a “defendant-friendly” rule is more likely to minimize error costs.

As Commissioner Wright observed, economic theory and empirical evidence about minimum RPM’s competitive effects, as well as intuitions about the magnitude of those various effects, suggest that minimum RPM ought to be subject to a defendant-friendly liability rule that puts the burden on plaintiffs to establish actual or likely competitive harm. With respect to economic theory, procompetitive benefit from RPM is more likely because the necessary conditions for RPM’s anticompetitive effects are rarely satisfied, while the prerequisites to procompetitive benefit often exist. Not surprisingly, then, most studies of minimum RPM have concluded that it is more frequently used to enhance rather than reduce market output. (As I have elsewhere observed and Commissioner Wright acknowledged, the one recent outlier study is methodologically flawed.) In terms of the magnitude of harms from wrongly condemning or wrongly approving instances of RPM, there are good reasons to believe greater harm will result from the former sort of error. The social harm from a false acquittal – enhanced market power – is self-correcting; market power invites entry. A false condemnation, by contrast, can be corrected only by a subsequent judicial, regulatory, or legislative overruling.  Moreover, an improper conviction thwarts not just the challenged instance of RPM but also instances contemplated by business planners who would seek to avoid antitrust liability. Taken together, these considerations about the probability and magnitude of various competitive effects argue in favor of a fairly lenient liability rule for minimum RPM – certainly not per se illegality or a “quick look” approach that deems RPM to be inherently suspect and places the burden on the defendant to rebut a presumption of anticompetitive harm.

Commissioner Wright’s call for a more probing rule of reason for minimum RPM represents a substantial improvement on the approach the FTC took in the wake of the U.S. Supreme Court’s 2007 Leegin decision. Shortly after Leegin abrogated the rule of per se illegality for minimum RPM, women’s shoe manufacturer Nine West petitioned the Commission to modify a pre-Leegin consent decree constraining Nine West’s use of RPM arrangements. In agreeing to modify (but not eliminate) the restrictions, the Commission endorsed a liability rule that would deem RPM to be inherently suspect (and thus presumptively illegal) unless the defendant could establish an absence of the so-called “Leegin factors” – i.e., that there was no dealer or manufacturer market power, that RPM was not widely used in the relevant market, and that the RPM at issue was not dealer-initiated.

The FTC’s fairly pro-plaintiff approach was deficient in that it simply lifted a few words from Leegin without paying close attention to the economics of RPM. As Commissioner Wright explained,

[C]ritical to any decision to structure the rule of reason for minimum RPM is that the relevant analytical factors correctly match the economic evidence. For instance, some of the factors identified by the Leegin Court as relevant for identifying whether a particular minimum RPM agreement might be anticompetitive actually shed little light on competitive effects. For example, the Leegin Court noted that “the source of the constraint might also be an important consideration” and observed that retailer-initiated restraints are more likely to be anticompetitive than manufacturer-initiated restraints. But economic evidence recognizes that because retailers in effect sell promotional services to manufacturers and benefit from such contracts, it is equally as possible that retailers will initiate minimum RPM agreements as manufacturers. Imposing a structured rule of reason standard that treats retailer-initiated minimum RPM more restrictively would thus undermine the benefits of the rule of reason.

Commissioner Wright’s remarks give me hope that the FTC will eventually embrace an economically sensible liability rule for RPM. Now, if we could only get those pesky state policy makers to modernize their outdated RPM thinking.  As Commissioner Wright recently observed, policy advocacy “is a weapon the FTC has wielded effectively and consistently over time.” Perhaps the Commission, spurred by Wright, will exercise its policy advocacy prowess on the backward states that continue to demonize minimum RPM arrangements.

FTC Commissioner Josh Wright pens an incredibly important dissent in the FTC’s recent Ardagh/Saint-Gobain merger review.

At issue is how pro-competitive efficiencies should be considered by the agency under the Merger Guidelines.

As Josh notes, the core problem is the burden of proof:

Merger analysis is by its nature a predictive enterprise. Thinking rigorously about probabilistic assessment of competitive harms is an appropriate approach from an economic perspective. However, there is some reason for concern that the approach applied to efficiencies is deterministic in practice. In other words, there is a potentially dangerous asymmetry from a consumer welfare perspective of an approach that embraces probabilistic prediction, estimation, presumption, and simulation of anticompetitive effects on the one hand but requires efficiencies to be proven on the other.

In the summer of 1995, I spent a few weeks at the FTC. It was the end of the summer and nearly the entire office was on vacation, so I was left dealing with the most arduous tasks. In addition to fielding calls from Joe Sims prodding the agency to finish the Turner/Time Warner merger consent, I also worked on early drafting of the efficiencies defense, which was eventually incorporated into the 1997 Merger Guidelines revision.

The efficiencies defense was added to the Guidelines specifically to correct a defect of the pre-1997 Guidelines era in which

It is unlikely that efficiencies were recognized as an antitrust defense…. Even if efficiencies were thought to have a significant impact on the outcome of the case, the 1984 Guidelines stated that the defense should be based on “clear and convincing” evidence. Appeals Court Judge and former Assistant Attorney General for Antitrust Ginsburg has recently called reaching this standard “well-nigh impossible.” Further, even if defendants can meet this level of proof, only efficiencies in the relevant anticompetitive market may count.

The clear intention was to ensure better outcomes by ensuring that net pro-competitive mergers wouldn’t be thwarted. But even under the 1997 (and still under the 2010) Guidelines,

the merging firms must substantiate efficiency claims so that the Agency can verify by reasonable means the likelihood and magnitude of each asserted efficiency, how and when each would be achieved (and any costs of doing so), how each would enhance the merged firm’s ability and incentive to compete, and why each would be merger-specific. Efficiency claims will not be considered if they are vague or speculative or otherwise cannot be verified by reasonable means.

The 2006 Guidelines Commentary further supports the notion that the parties bear a substantial burden of demonstrating efficiencies.

As Josh notes, however:

Efficiencies, like anticompetitive effects, cannot and should not be presumed into existence. However, symmetrical treatment in both theory and practice of evidence proffered to discharge the respective burdens of proof facing the agencies and merging parties is necessary for consumer‐welfare based merger policy

There is no economic basis for demanding more proof of claimed efficiencies than of claimed anticompetitive harms. And the Guidelines since 1997 were (ostensibly) drafted in part precisely to ensure that efficiencies were appropriately considered by the agencies (and the courts) in their enforcement decisions.

But as Josh notes, this has not really been the case, much to the detriment of consumer-welfare-enhancing merger review:

To the extent the Merger Guidelines are interpreted or applied to impose asymmetric burdens upon the agencies and parties to establish anticompetitive effects and efficiencies, respectively, such interpretations do not make economic sense and are inconsistent with a merger policy designed to promote consumer welfare. Application of a more symmetric standard is unlikely to allow, as the Commission alludes to, the efficiencies defense to “swallow the whole of Section 7 of the Clayton Act.” A cursory read of the cases is sufficient to put to rest any concerns that the efficiencies defense is a mortal threat to agency activity under the Clayton Act. The much more pressing concern at present is whether application of asymmetric burdens of proof in merger review will swallow the efficiencies defense.

It benefits consumers to permit mergers that offer efficiencies that offset presumed anticompetitive effects. To the extent that the agencies, as in the Ardagh/Saint-Gobain merger, discount efficiencies evidence relative to their treatment of anticompetitive effects evidence, consumers will be harmed and the agencies will fail to fulfill their mandate.

This is an enormously significant issue, and Josh should be widely commended for raising it in this case. With luck it will spur a broader discussion and, someday, a more appropriate treatment in the Guidelines and by the agencies of merger efficiencies.

 

Commissioner Josh Wright’s dissenting statement in the Federal Trade Commission’s recent McWane proceeding is a must-read for anyone interested in the law and economics of exclusive dealing. Wright dissented from the Commission’s holding that McWane Inc.’s “full support” policy constituted unlawful monopolization of the market for domestic pipe fittings.

Under the challenged policy, McWane, the dominant producer with a 45-50% share of the market for domestic pipe fittings, would sell its products only to distributors that “fully supported” its fittings by carrying them exclusively.  There were two exceptions: where McWane products were not readily available, and where the distributor purchased a McWane rival’s pipe along with its fittings.  A majority of the Commission ruled that McWane’s policy constituted illegal exclusive dealing.  Commissioner Wright agreed that the policy amounted to exclusive dealing, but he concluded that the complainant had failed to prove that the exclusive dealing constituted unreasonably exclusionary conduct in violation of Sherman Act Section 2.

The first half of Wright’s 52-page dissent is an explanatory tour de force.  Wright first explains how and why the Supreme Court rethought its originally inhospitable rules on “vertical restraints” (i.e., trade-limiting agreements between sellers at different levels of the distribution system, such as manufacturers and distributors).  Recognizing that most such restraints enhance overall market output even if they incidentally injure some market participants, courts now condition liability on harm to competition—that is, to overall market output.  Mere harm to an individual competitor is not enough.

Wright then explains how this “harm to competition” requirement manifests itself in actions challenging exclusive dealing.  Several of the antitrust laws—Sections 1 and 2 of the Sherman Act and Section 3 of the Clayton Act—could condemn arrangements in which a seller will deal only with those who purchase its brand exclusively.  Regardless of the particular statute invoked, though, there can be no antitrust liability absent either direct or indirect evidence of anticompetitive (not just anti-competitor) effect.  Direct evidence entails some showing that the exclusive dealing at issue led to lower market output and/or higher prices than would otherwise have prevailed.  Indirect evidence usually involves showings that (1) the exclusive dealing at issue foreclosed the defendant’s rivals from a substantial share of available marketing opportunities; (2) those rivals were therefore driven (or held) below minimum efficient scale (MES), so that their per-unit production costs were held artificially high; and (3) the defendant thereby obtained the ability to price higher than it would have absent the exclusive dealing.

The McWane complainant, Star Pipe Products, Ltd., sought to discharge its proof burden using indirect evidence. It asserted that its per-unit costs would have been lower if it owned a domestic foundry, but it maintained that its 20% market share did not entail sales sufficient to justify foundry construction.  Thus, Star concluded, McWane’s usurping of rivals’ potential sales opportunities through its exclusive dealing policy held Star below MES, raised Star’s per-unit costs, and enhanced McWane’s ability to raise prices.  Voila!  Anticompetitive harm.

Commissioner Wright was not convinced that Star had properly equated MES with sales sufficient to justify foundry construction.  The only record evidence to that effect—evidence the Commission deemed sufficient—was Star’s self-serving testimony that it couldn’t justify building a foundry at its low level of sales and would be a more formidable competitor if it could do so.  Countering that testimony were a couple of critical bits of actual market evidence.

First, the second-largest domestic seller of pipe fittings, Sigma Corp., somehow managed to enter the domestic fittings market and capture a 30% market share (as opposed to Star’s 20%), without owning any of its own production facilities.  Sigma’s entire business model was built on outsourcing, yet it managed to grow sales more than Star.  This suggests that foundry ownership – and, thus, a level of sales sufficient to support foundry construction – may not be necessary for efficient scale in this industry.

Moreover, Star’s own success in the domestic pipe fittings market undermined its suggestion that MES can be achieved only upon reaching a sales level sufficient to support a domestic foundry.  Star entered the domestic pipe fittings market in 2009, quickly grew to a 20% market share, and was on pace to continue growth when the McWane action commenced.  As Commissioner Wright observed, “for Complaint Counsel’s view of MES to make sense on the facts that exist in the record, Star would have to be operating below MES, becoming less efficient over time as McWane’s Full Support Program further raised the costs of distribution, and yet remaining in the market and growing its business.  Such a position strains credulity.”

Besides failing to establish what constitutes MES in the domestic pipe fittings industry, Commissioner Wright asserted, complainant Star also failed to prove the degree of foreclosure occasioned by McWane’s full support program.

First, both Star and the Commission reasoned that all McWane sales to distributors subject to its full support program had been “foreclosed,” via exclusive dealing, to McWane’s competitors.  That is incorrect.  The sales opportunities foreclosed by McWane’s full support policy were those that would have been made to other sellers but for the policy.  In other words, if a distributor, absent the full support policy, would have purchased 70 units from McWane and five from Star but, because of the full support program, purchased all 75 from McWane, the full support program effectively foreclosed Star from five sales opportunities, not 75.  By failing to focus on “contestable” sales—i.e., sales other than those that would have been made to McWane even absent the full support program—Star and the Commission exaggerated the degree of foreclosure resulting from McWane’s exclusive dealing.

Second, neither Star nor the Commission made any effort to quantify the sales made to McWane’s rivals under the two exceptions to McWane’s full support policy.  Such sales were obviously not foreclosed to McWane’s rivals, but both Star and the Commission essentially ignored them.  So, for example, if a distributor that carried McWane’s products (and was thus subject to the full support policy) purchased 70 domestic fittings from McWane and 30 from other producers pursuant to one of the full support program’s exceptions, Star and the Commission counted 100 foreclosed sales opportunities.  Absent information about the number of distributor purchases under exceptions to the full support program, it is simply impossible to assess the degree of foreclosure occasioned by the policy.

In sum, complainant Star – who bore the burden of establishing an anticompetitive (i.e., market output-reducing) effect of the exclusive dealing at issue – failed to show how much foreclosure McWane’s full support program actually created and to produce credible evidence (other than its own self-serving testimony) that the program raised its costs by holding it below MES.  The most Star showed was harm to a competitor – not harm to competition, a prerequisite to liability based on exclusive dealing.      

In addition, several other pieces of evidence suggested that McWane’s exclusive dealing was not anticompetitive.  First, the full support program did not require a commitment of exclusivity for any period of time. Distributors purchasing from McWane could begin carrying rival brands at any point (though doing so might cause McWane to refuse to sell to them in the future).  Courts have often held that short-duration exclusive dealing arrangements are less troubling than longer-term agreements; indeed, a number of courts presume the legality of exclusive dealing contracts of a year or less.  McWane’s policy was of no, not just short, duration.

Second, entry considerations suggested an absence of anticompetitive harm here.  If entry into a market is easy, there is little need to worry that exclusionary conduct will produce market power.  Once the monopolist begins to exercise its power by reducing output and raising price, new entrants will appear on the scene, driving price and output back to competitive levels.  The recent and successful entry of both Star and Sigma, who collectively gained about half the total market share within a short period of time, suggested that entry into the domestic pipe fittings market is easy.

Finally, evidence of actual market performance indicated that McWane’s exclusive dealing policies did not generate anticompetitive effect.  McWane enforced its full support program for the first year of Star’s participation in the domestic fittings market, but not thereafter.  Star’s growth rate, however, was identical before and after McWane stopped enforcing the program.  According to Commissioner Wright, “Neither Complaint Counsel nor the Commission attempt[ed] to explain how growth that is equal with and without the Full Support Program is consistent with Complaint Counsel’s theory of harm that the Program raised Star’s costs of distribution and impaired competition.  The most plausible inference to draw from these particular facts is that the Full Support Program had almost no impact on Star’s ability to enter and grow its business, which, under the case law, strongly counsels against holding that McWane’s conduct was exclusionary.”

***

Because antitrust exists to protect competition, not competitors, an antitrust complainant cannot base a claim of monopolization on the mere fact that its business was injured by the defendant’s conduct.  By the same token, a party complaining of unreasonably exclusionary conduct also ought not to prevail simply because it made self-serving assertions that it would have had more business but for the defendant’s action and would have had lower per-unit costs if it had more business.  If the antitrust is to remain a consumer-focused body of law, claims like Star’s should fail.  Hopefully, Commissioner Wright’s FTC colleagues will eventually see that point.

The following is the third in a series of guest posts by David Balto about the FTC’s McWane case.

A particularly unsettling aspect of the FTC’s case against McWane is the complaint counsel’s heavy (and seemingly exclusive) reliance on structural factors to prove its case. The FTC has little or no direct evidence of price communications and no econometric evidence suggesting collusion, and has instead spent a good deal of time trying to show that the market is susceptible to collusion. What makes the FTC’s administrative case so unsettling is that the structural factors they rely on are true of any oligopoly and, in federal courts across the country, are insufficient as a matter of law to raise an inference of conspiracy.

When there are a small number of actors in a market they naturally act and react differently than markets with many competitors. As an example, imagine it’s the final chess tournament between two capable opponents. At one point of the game one player makes a move knowing that it will likely force her opponent to make a move that will later work to her advantage. The opponent makes this move and the referees stop the match. The referees say the opponent moved in a way that was advantageous to the player who proves this game is rigged. The referees further explain that because there are only the two of them playing and because they know each other that this game of chess is susceptible to cheating. Because the game is susceptible to cheating, the referees declare, the evidence that the opponent made a move advantageous to player is all the evidence the referees need to stop the game.

Obviously the situation described in the chess example would never occur. It is common in two party games for one player to force another player into taking a particular move. No referee would stop a match with such flimsy evidence. However, the FTC seeks to find McWane liable of collusion under similar circumstances.

Ductile iron pipe fittings (DIPF) are commodities and the DIPF market is an oligopoly with only three major players:  McWane, Sigma and Star. Each DIPF supplier constantly tries to monitor its rivals’ prices because if a competitor undercuts it, its sales volume will fall. Each DIPF supplier is also susceptible to rising costs caused by market conditions and has similar motivations to raise prices to account for rising costs. Complaint counsel argues that these characteristics make the fittings market “susceptible” or “conducive” to collusion, which shows a motive to conspire.  The Administrative Law Judge (ALJ) did not find complaint counsel’s argument persuasive.

The collusion case against McWane came down to whether there was an agreement among competitors to curtail project pricing. As such, the ALJ sought to determine whether or not the evidence shows:  (1) a prior understanding among the Suppliers, including McWane, that each Supplier would curtail Project Pricing; (2) a commitment to one another to curtail Project Pricing; (3) a restricted freedom of action and sense of obligation to one another to curtail Project Pricing, and (4) an actual reduction in the amount or level of Project Pricing. Consistent with prevailing federal court caselaw, the ALJ demanded evidence indicating an “actual, manifest agreement” and found that evidence lacking.

Unfortunately for complaint counsel, the evidence it put on is also suggestive of interdependence and conscious parallelism among oligopolists, which are not violations of the law. It was in McWane’s interests to get its competitors to curtail project pricing so it could better determine the real prices it needed to “further its own legitimate business interests of increasing volume . . . in order to beat prices being offered by its competitors, which is a procompetitive purpose.”. McWane used its position as a price leader to make a move that it hoped would force McWane’s competitors to reduce project pricing. Despite large raw material cost increases, McWane refused to raise published list prices to the high levels Sigma and Star had announced, and it set its regional multipliers in such a way that would pressure those competitors to match its lower multipliers and, it hoped, to reduce their project pricing.

McWane’s strategy did not require or lead to an “actual, manifest agreement” on multipliers or project pricing, as complaint counsel alleges. The ALJ found that “If Sigma and Star declined to adopt McWane’s new multipliers, the new multipliers could be easily withdrawn or revised.” The ALJ determined that McWane’s move was not irrational because McWane could still easily react based on the behavior of its competitors. Indeed, the ALJ found that it was “undisputed that Project Pricing did not stop,” and found no evidence that Project Pricing declined at all.

On the collusion issue, the ALJ rightly found that price maneuvering in an oligopoly is not a violation without sufficient evidence to show there was an actual, manifest agreement. If the FTC were to do so it would open many markets up to additional risk. It would also be impossible to craft a remedy without grossly interfering with the normal operation of the market. In this, the ALJ reiterated the sentiment of the First Circuit – “How does one order a firm to set its prices without regard to the likely reactions of its competitors?”

The FTC Commissioners should not hold a company guilty of collusion simply for being a part of an oligopoly. As the ALJ stated – “accepting Complaint Counsel’s position that oligopolistic interdependence is a ‘plus’ factor would, in effect, foist a nefarious motive upon the Suppliers merely because they conduct their business within an oligopoly market. This is not the law.” The ALJ was right, and it would be inconsistent with well-established federal court caselaw to rule otherwise.  The FTC should not be subject to one rule in federal court, but another for its own internal administrative court.

The following is the second in a series of guest posts by David Balto about the FTC’s McWane case.

Two modest offices on the first floor of the FTC building are occupied by the FTC Administrative Law Judge and his staff.  Of all of the agencies with an ALJ, the FTC’s operation must be the smallest.  The ALJ handles only a handful of trials each year.  In the past, the FTC ALJ operation has gathered little to no attention.  But in recent years, with renewed focus on administrative litigation and tight litigation deadlines, FTC administrative litigation has become a rocket docket of sorts.

But there is renewed attention for another reason.  As I have written elsewhere the FTC is on a 19-year streak of always finding violations in its administrative litigation.  In many instances that has required it to reverse an ALJ.  When the Commission reverses on the law, that is not exceptional.  But in those cases where the Commission has taken a different view of the facts, there is far greater controversy.  Although the Commission does analyze the facts de novo, the ALJ has conducted the trial, listened to the testimony, watched the witnesses and is in the best position to assess credibility and determine the facts.  The Commission’s differing view of the facts in cases such as Rambus and Schering led appellate courts to treat the FTC decision with extreme skepticism.  If the FTC is going to second guess the ALJ’s factual findings, which are based on his first-hand observation of the witnesses and review of the documents, why do we have ALJs?

This post addresses that issue by looking at the factual findings of the ALJ in the McWane case (for an introduction of the McWane case please see my previous post). The ALJ in the McWane case wrote an extensive 235 pages of factual findings. In the interest of brevity, I will only be discussing the collusion findings.  My goal is to illustrate how difficult it will be to reverse some of these findings, and if reversed, the problems it will likely present on appeal.

To understand the FTC’s collusion claims it is important to first understand how fittings are priced. Fitting prices start with published list prices. No one buys off published prices.  The suppliers publish regional multipliers that provide discounts off the published list price. The ALJ found that “[d]istributors prefer that [f]ittings suppliers like McWane, Sigma, and Star have identical list prices because it is easier for [d]istributors to compare the suppliers’ multipliers and discounts to determine net prices.” Suppliers also have a variety of mechanisms to discount prices below the multiplier price in order to compete for bids. Chief among these is the project price, which is a discounted price for an entire project or job or for a single order. It is easy for competitors to find out each other’s list prices and multipliers from their customers which are often large and aggressive buyers who bargain down prices. However, discounts beyond the multipliers are often hidden and hard to discover by competitors.

The ALJ found the fittings market to be an oligopoly. McWane, Sigma, and Star are constantly looking for, and reacting to, changes in each other’s pricing. Much of this competitive information was received through customers and it was known that any letter sent to a customer would end up in the hands of a competitor. The ALJ found that while “[c]ustomer letters served to communicate to competitors, as well as customers[,]”the “substantial evidence” showed that the parties priced independently at all times and McWane routinely priced below its competitors.

Beginning in 2007, “the [f]ittings industry experienced a period of declining demand, increased price competition resulting in price erosion, and increased costs.” The ALJ found that during this period McWane’s main concern was to increase sales volume in order to reduce excess inventory and keep its foundries open. The ALJ also found that McWane’s net pricing was not keeping up with cost inflation. The cost of doing business overseas, primarily in China, was also increasing, which impacted all fittings suppliers equally. Every supplier was looking to increase pricing but the suppliers were also aware that any increase would have to be followed to stick.

McWane used these conditions to allegedly come up with a strategy, which later became the basis for the FTC’s complaint, to “narrow the range between the published price and actual prices and thereby give his competitors less ‘headroom,’ within which Star and Sigma could maneuver to undercut McWane on price.” Instead of following Star and Sigma on their very large list price increases, McWane kept its list prices steady and raised some its multipliers, but to a much lower amount than Sigma and Star’s list price increases. McWane also announced an intention to stop project pricing through customer letters, according to the FTC. Project pricing hides the real prices of fittings. McWane’s goal was to make prices more transparent so that it could better compete on price but “McWane knew internally that in order to meet its objectives of increasing volume and share, it would have to Project Price.”

The FTC also had a problem with the beginning of a fittings trade group called DIFRA. The FTC’s claim was that DIFRA allowed the fittings companies to share sensitive competitive data. McWane, Star and Sigma would report “tons-shipped data” to DIFRA for their fittings sales. The ALJ found that the data gathered by DIFRA’s accountants “did not distinguish between Domestic Fittings and non-domestic Fittings” and “did not include or reveal any sales Prices.” The ALJ also found that “no DIFRA member was permitted to review the tons-shipped data of any other member; the reports revealed only the aggregate total tons-shipped during the relevant reporting period.” This DIFRA data was used by each supplier to determine their market share in order to plan future business strategies.

The FTC believed that McWane’s strategy, DIFRA, and other activities were collusive actions to stabilize and raise prices. The FTC saw the alleged elimination of project pricing and sharing of aggregated volume data as mechanisms to enforce a cartel and prevent cheating. However, the ALJ did not find these activities to amount to anticompetitive behavior – there was no smoking gun that turned these activities with procompetitive justifications into an antitrust violation. The data DIFRA provided had procompetitive uses including an instance where it “helped McWane decide, in June 2008, to choose the low end of the 8% to 12% range of multiplier increases” because the report showed McWane was “continuing to lose market share.” The ALJ also found that the data did not suggest a reduction in job pricing. The expert in the trial, which the ALJ found “offered credible and persuasive expert opinion, based on actual prices,” found “no economic evidence that the price changes in January or June of 2008 were coordinated, or that there was an agreement to reduce job pricing as would be reflected in a decrease in price variance; that there was economic evidence that contradicted a conclusion that prices were raised anticompetitively in the Fittings market; and that the pattern of sales and inventory contradicts the notion of quantity withholding, as would be needed to effect a price increase.” The ALJ also found that McWane’s witness “credibly testified that McWane’s goal going into 2008 was primarily to increase volume, rather than price,” and that “[t]he decline in McWane’s pricing (F. 940), given the rise in input costs (F. 951), is inconsistent with a conspiracy and consistent with independent pricing behavior.”

The ALJ ultimately found that the government’s collusion claims amounted to nothing more than “weak” “unsupported speculation” and that its “daisy chain of assumptions fails to support or justify an evidentiary inference of any unlawful agreement involving McWane.” The FTC will have trouble overcoming these findings if it chooses to overturn the ALJ’s dismissal of the collusion claims. For the Commissioners to do so would essentially be making different credibility assessments than the ALJ, even though they weren’t present for the trial. If these ALJ findings are so easily overturned it would bring into question why an ALJ is needed in the first place.

The following is the first in a series of guests posts by David Balto about the FTC’s McWane case.

Anyone familiar with the antitrust newstream realizes there is a tremendous amount of controversy about the Federal Trade Commission’s administrative litigation process. Unlike the Antitrust Division which fights its litigation battles in Federal Court, the FTC has a distinct home court advantage. FTC antitrust cases are typically litigated administratively with a trial conducted before an FTC administrative law judge, who issues an initial decision, followed with an appeal to the full Commission for a final decision. I have authored a couple of recent articles as have others that question the fairness of the FTC acting as both prosecutor and judge. These concerns have only been amplified since for the last 19 years the FTC has always found a violation of law. As one Congressman noted the FTC has “an unbeaten streak that Perry Mason would envy.”

All of this will come to a head later this month in an FTC case against McWane, Inc., a modest firm that makes ductile iron pipe fittings (DIPF). In this case the FTC brought a complaint against McWane alleging collusion with competitors to stabilize and raise prices and exclusion of competitors in the domestically manufactured DIPF market. The case was tried like greased lightning – it went from complaint to trial in 9 months. The trial before the administrative law judge (ALJ) involved over 2,000 exhibits, 16 live witnesses and 53 total witnesses, 25 trial days, 6,045 pages of trial transcript, and culminated in a 464-page decision – possibly the longest FTC decision in history. Ultimately, the ALJ split his decision and found for McWane on the collusion counts and for the FTC on the exclusion counts. Both parties have appealed and the case is currently under consideration by the Commission. The case was argued before the Commission on August 22, 2013, and a decision by the Commission is expected by January 25.

The McWane case provides an excellent lens to examine where the FTC may be headed in administrative litigation and the policing of dominant firm conduct. For this reason I will be writing a series of posts explaining the case and why a finding of a violation may be a risky path for the development of the law on collusion and exclusion, and what proof is needed to show such violations. This first article will explain the state of the market that led to the filing of a complaint.

McWane is a producer of domestically manufactured DIPF, which are used to join pipe in pressurized water transportation systems. DIPF can join pipe in straight lines or change, divide or direct the flow of water. DIPF are usually sold to municipal and regional water authorities through independent wholesale distributors. DIPF are commodity products that are produced to American Water Works Association standards. This makes all DIPF that meet the standards, whether foreign or domestically produced, completely interchangeable.

The DIPF market used to be dominated by domestic producers; however that has changed over the past 20 years. Project managers and municipalities can stipulate on their specifications whether the fittings for a particular project are to be domestically produced, imported, or open to all bids. Since the mid-1980s cheap foreign fittings and dumping has caused most of these specifications to be flipped from domestic-only to open. The period of 2003-2008 saw the biggest decline in domestic DIPF – from about 70% to 15-20%. This led many domestic fittings producers to either dramatically reduce their production or exit the market entirely. The International Trade Commission unanimously determined in 2003 that a flood of cheap fittings from China was causing “market disruption” and “material injury” to domestic fittings producers. McWane became the last domestic DIPF producer with a full-line foundry dedicated to DIPF in the United States and that foundry is only operating at 30% capacity, which puts it in danger of being closed. McWane was previously forced to shut down its other U.S. foundry and open a foundry in China, measures taken to compete with the low cost of foreign production.

There are still some specifications that require domestically produced fittings. This may be due to preference (ex. patriotism) or legal rules, but both of these can (and did) change with frequency to permit the purchase of imported fittings. In addition, the “Buy American” provisions of the American Recovery and Reinvestment Act (ARRA) did create a brief increase in the demand of domestically produced fittings. However, the numerous waivers and temporary nature meant that the sale of domestic fittings only rose to about a third of all sales before falling back to their pre-ARRA levels when ARRA expired in 2010. Domestic-only specifications and the ARRA period encouraged foreign fittings companies to consider producing DIPF products domestically. Star entered shortly after the passage of ARRA and Sigma entered into a Master Distribution Agreement (MDA) with McWane to supply domestic fittings during the ARRA period. It was these conditions that produced the FTC complaint.

McWane’s actions to keep its domestic foundry open led to the FTC complaint. McWane’s rebate program, designed to help it increase production at its foundry, became the basis of the FTC’s claim that McWane was excluding Star from the market. McWane’s MDA agreement with Sigma, which also helped expand its reach to Sigma’s customer base and to increase its domestic foundry production, was seen by the FTC as excluding Sigma from the market. McWane was also charged with colluding with Star, who successfully entered the market, to raise and stabilize prices.

The FTC’s complaint is divided into two parts with counts 1-3 alleging collusion and counts 4-7 alleging exclusionary actions by McWane. The collusion counts charge conspiracy to restrain price competition in the relevant Fittings market (Count One); conspiracy to exchange competitively sensitive sales information (Count Two); and invitation to collude (Count Three). The exclusionary counts charge that the MDA was an agreement in restraint of trade (Count Four); a conspiracy between McWane and Sigma to monopolize the Domestic Fittings market (Count Five); exclusionary acts constituting willful practices to acquire, enhance, or maintain monopoly power in the relevant Domestic Fittings market (Count Six); and specific intent to monopolize the Domestic Fittings market (Count Seven). The ALJ dismissed counts 1-3, finding that the FTC’s conspiracy allegations were “weak,” “unverified,” “unpersuasive,” “strained,” and “unsupported,” amounting to a “daisy chain of assumptions.” The ALJ went on to find that Star, who was a “a less efficient supplier” than McWane, “clearly” entered the Domestic Fittings market in 2009, and that its market share went “from zero to almost 10% in 2011.” He also found that “Sigma was in a precarious position overall in financial terms” and “regardless of whether Sigma had the financial capability to produce Domestic Fittings . . . it did not have the time required to do so” before the end of the ARRA period, but nonetheless found that counts 4-7 were proven by a preponderance of the evidence.

The McWane case is unusual for several reasons as I will describe in my future posts. The FTC alleges collusion to raise and stabilize prices and exclusionary conduct but the time period of any alleged wrongful conduct seems incredibly short. The FTC alleges that the victim of McWane’s supposed exclusionary tactics, Star, also conspired with McWane to raise prices – a contradiction that FTC Commissioner Rosch had trouble with. The FTC relies heavily on a domestic market definition even though there is strong evidence that foreign competition had driven all domestic suppliers out of the market except for McWane and that any domestic only market, if it exists, does not appear to be large enough or stable enough to support an industry. Finally, The FTC relies on structural and plus factors to prove collusion rather than direct evidence of price agreements or communications or economic evidence and analyses showing any supra-competitive price effects.

In my next article I will explain the ALJ’s factual findings in relation to the alleged violations and pose some of the challenges the Commission faces.

As it begins its hundredth year, the FTC is increasingly becoming the Federal Technology Commission. The agency’s role in regulating data security, privacy, the Internet of Things, high-tech antitrust and patents, among other things, has once again brought to the forefront the question of the agency’s discretion and the sources of the limits on its power.Please join us this Monday, December 16th, for a half-day conference launching the year-long “FTC: Technology & Reform Project,” which will assess both process and substance at the FTC and recommend concrete reforms to help ensure that the FTC continues to make consumers better off.

FTC Commissioner Josh Wright will give a keynote luncheon address titled, “The Need for Limits on Agency Discretion and the Case for Section 5 UMC Guidelines.” Project members will discuss the themes raised in our inaugural report and how they might inform some of the most pressing issues of FTC process and substance confronting the FTC, Congress and the courts. The afternoon will conclude with a Fireside Chat with former FTC Chairmen Tim Muris and Bill Kovacic, followed by a cocktail reception.

Full Agenda:

  • Lunch and Keynote Address (12:00-1:00)
    • FTC Commissioner Joshua Wright
  • Introduction to the Project and the “Questions & Frameworks” Report (1:00-1:15)
    • Gus Hurwitz, Geoffrey Manne and Berin Szoka
  • Panel 1: Limits on FTC Discretion: Institutional Structure & Economics (1:15-2:30)
    • Jeffrey Eisenach (AEI | Former Economist, BE)
    • Todd Zywicki (GMU Law | Former Director, OPP)
    • Tad Lipsky (Latham & Watkins)
    • Geoffrey Manne (ICLE) (moderator)
  • Panel 2: Section 5 and the Future of the FTC (2:45-4:00)
    • Paul Rubin (Emory University Law and Economics | Former Director of Advertising Economics, BE)
    • James Cooper (GMU Law | Former Acting Director, OPP)
    • Gus Hurwitz (University of Nebraska Law)
    • Berin Szoka (TechFreedom) (moderator)
  • A Fireside Chat with Former FTC Chairmen (4:15-5:30)
    • Tim Muris (Former FTC Chairman | George Mason University) & Bill Kovacic (Former FTC Chairman | George Washington University)
  • Reception (5:30-6:30)
Our conference is a “widely-attended event.” Registration is $75 but free for nonprofit, media and government attendees. Space is limited, so RSVP today!

Working Group Members:
Howard Beales
Terry Calvani
James Cooper
Jeffrey Eisenach
Gus Hurwitz
Thom Lambert
Tad Lipsky
Geoffrey Manne
Timothy Muris
Paul Rubin
Joanna Shepherd-Bailey
Joe Sims
Berin Szoka
Sasha Volokh
Todd Zywicki

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Please join us at the Willard Hotel in Washington, DC on December 16th for a conference launching the year-long project, “FTC: Technology and Reform.” With complex technological issues increasingly on the FTC’s docket, we will consider what it means that the FTC is fast becoming the Federal Technology Commission.

The FTC: Technology & Reform Project brings together a unique collection of experts on the law, economics, and technology of competition and consumer protection to consider challenges facing the FTC in general, and especially regarding its regulation of technology.

For many, new technologies represent “challenges” to the agency, a continuous stream of complex threats to consumers that can be mitigated only by ongoing regulatory vigilance. We view technology differently, as an overwhelmingly positive force for consumers. To us, the FTC’s role is to promote the consumer benefits of new technology — not to “tame the beast” but to intervene only with caution, when the likely consumer benefits of regulation outweigh the risk of regulatory error. This conference is the start of a year-long project that will recommend concrete reforms to ensure that the FTC’s treatment of technology works to make consumers better off. Continue Reading…

The Children’s Online Privacy Protection Act (COPPA) continues to be a hot button issue for many online businesses and privacy advocates. On November 14, Senator Markey, along with Senator Kirk and Representatives Barton and Rush introduced the Do Not Track Kids Act of 2013 to amend the statute to include children from 13-15 and add new requirements, like an eraser button. The current COPPA Rule, since the FTC’s recent update went into effect this past summer, requires parental consent before businesses can collect information about children online, including relatively de-identified information like IP addresses and device numbers that allow for targeted advertising.

Often, the debate about COPPA is framed in a way that makes it very difficult to discuss as a policy matter. With the stated purpose of “enhanc[ing] parental involvement in children’s online activities in order to protect children’s privacy,” who can really object? While there is recognition that there are substantial costs to COPPA compliance (including foregone innovation and investment in children’s media), it’s generally taken for granted by all that the Rule is necessary to protect children online. But it has never been clear what COPPA is supposed to help us protect our children from.

Then-Representative Markey’s original speech suggested one possible answer in “protect[ing] children’s safety when they visit and post information on public chat rooms and message boards.” If COPPA is to be understood in this light, the newest COPPA revision from the FTC and the proposed Do Not Track Kids Act of 2013 largely miss the mark. It seems unlikely that proponents worry about children or teens posting their IP address or device numbers online, allowing online predators to look at this information and track them down. Rather, the clear goal animating the updates to COPPA is to “protect” children from online behavioral advertising. Here’s now-Senator Markey’s press statement:

“The speed with which Facebook is pushing teens to share their sensitive, personal information widely and publicly online must spur Congress to act commensurately to put strong privacy protections on the books for teens and parents,” said Senator Markey. “Now is the time to pass the bipartisan Do Not Track Kids Act so that children and teens don’t have their information collected and sold to the highest bidder. Corporations like Facebook should not be profiting from the personal and sensitive information of children and teens, and parents and teens should have the right to control their personal information online.”

The concern about online behavioral advertising could probably be understood in at least three ways, but each of them is flawed.

  1. Creepiness. Some people believe there is something just “creepy” about companies collecting data on consumers, especially when it comes to children and teens. While nearly everyone would agree that surreptitiously collecting data like email addresses or physical addresses without consent is wrong, many would probably prefer to trade data like IP addresses and device numbers for free content (as nearly everyone does every day on the Internet). It is also unclear that COPPA is the answer to this type of problem, even if it could be defined. As Adam Thierer has pointed out, parents are in a much better position than government regulators or even companies to protect their children from privacy practices they don’t like.
  2. Exploitation. Another way to understand the concern is that companies are exploiting consumers by making money off their data without consumers getting any value. But this fundamentally ignores the multi-sided market at play here. Users trade information for a free service, whether it be Facebook, Google, or Twitter. These services then monetize that information by creating profiles and selling that to advertisers. Advertisers then place ads based on that information with the hopes of increasing sales. In the end, though, companies make money only when consumers buy their products. Free content funded by such advertising is likely a win-win-win for everyone involved.
  3. False Consciousness. A third way to understand the concern over behavioral advertising is that corporations can convince consumers to buy things they don’t need or really want through advertising. Much of this is driven by what Jack Calfee called The Fear of Persuasion: many people don’t understand the beneficial effects of advertising in increasing the information available to consumers and, as a result, misdiagnose the role of advertising. Even accepting this false consciousness theory, the difficulty for COPPA is that no one has ever explained why advertising is a harm to children or teens. If anything, online behavioral advertising is less of a harm to teens and children than adults for one simple reason: Children and teens can’t (usually) buy anything! Kids and teens need their parents’ credit cards in order to buy stuff online. This means that parental involvement is already necessary, and has little need of further empowerment by government regulation.

COPPA may have benefits in preserving children’s safety — as Markey once put it — beyond what underlying laws, industry self-regulation and parental involvement can offer. But as we work to update the law, we shouldn’t allow the Rule to be a solution in search of a problem. It is incumbent upon Markey and other supporters of the latest amendment to demonstrate that the amendment will serve to actually protect kids from something they need protecting from. Absent that, the costs very likely outweigh the benefits.

Below is the text of my oral testimony to the Senate Commerce, Science and Transportation Committee, the Consumer Protection, Product Safety, and Insurance Subcommittee, at its November 7, 2013 hearing on “Demand Letters and Consumer Protection: Examining Deceptive Practices by Patent Assertion Entities.” Information on the hearing is here, including an archived webcast of the hearing. My much longer and more indepth written testimony is here.

Please note that I am incorrectly identified on the hearing website as speaking on behalf of the Center for the Protection of Intellectual Property (CPIP). In fact, I was invited to testify soley in my personal capacity as a Professor of Law at George Mason University School of Law, given my academic research into the history of the patent system and the role of licensing and commercialization in the distribution of patented innovation. I spoke for neither George Mason University nor CPIP, and thus I am solely responsible for the content of my research and remarks.

Chairman McCaskill, Ranking Member Heller, and Members of the Subcommittee:

Thank you for this opportunity to speak with you today.

There certainly are bad actors, deceptive demand letters, and frivolous litigation in the patent system. The important question, though, is whether there is a systemic problem requiring further systemic revisions to the patent system. There is no answer to this question, and this is the case for three reasons.

Harm to Innovation

First, the calls to rush to enact systemic revisions to the patent system are being made without established evidence there is in fact systemic harm to innovation, let alone any harm to the consumers that Section 5 authorizes the FTC to protect. As the Government Accountability Office found in its August 2013 report on patent litigation, the frequently-cited studies claiming harms are actually “nonrandom and nongeneralizable,” which means they are unscientific and unreliable.

These anecdotal reports and unreliable studies do not prove there is a systemic problem requiring a systemic revision to patent licensing practices.

Of even greater concern is that the many changes to the patent system Congress is considering, incl. extending the FTC’s authority over demand letters, would impose serious costs on real innovators and thus do actual harm to America’s innovation economy and job growth.

From Charles Goodyear and Thomas Edison in the nineteenth century to IBM and Microsoft today, patent licensing has been essential in bringing patented innovation to the marketplace, creating economic growth and a flourishing society.  But expanding FTC authority to regulate requests for licensing royalties under vague evidentiary and legal standards only weakens patents and create costly uncertainty.

This will hamper America’s innovation economy—causing reduced economic growth, lost jobs, and reduced standards of living for everyone, incl. the consumers the FTC is charged to protect.

Existing Tools

Second, the Patent and Trademark Office (PTO) and courts have long had the legal tools to weed out bad patents and punish bad actors, and these tools were massively expanded just two years ago with the enactment of the America Invents Act.

This is important because the real concern with demand letters is that the underlying patents are invalid.

No one denies that owners of valid patents have the right to license their property or to sue infringers, or that patent owners can even make patent licensing their sole business model, as did Charles Goodyear and Elias Howe in the mid-nineteenth century.

There are too many of these tools to discuss in my brief remarks, but to name just a few: recipients of demand letters can sue patent owners in courts through declaratory judgment actions and invalidate bad patents. And the PTO now has four separate programs dedicated solely to weeding out bad patents.

For those who lack the knowledge or resources to access these legal tools, there are now numerous legal clinics, law firms and policy organizations that actively offer assistance.

Again, further systemic changes to the patent system are unwarranted because there are existing legal tools with established legal standards to address the bad actors and their bad patents.

If Congress enacts a law this year, then it should secure full funding for the PTO. Weakening patents and creating more uncertainties in the licensing process is not the solution.

Rhetoric

Lastly, Congress is being driven to revise the patent system on the basis of rhetoric and anecdote instead of objective evidence and reasoned explanations. While there are bad actors in the patent system, terms like PAE or patent troll constantly shift in meaning. These terms have been used to cover anyone who licenses patents, including universities, startups, companies that engage in R&D, and many others.

Classic American innovators in the nineteenth century like Thomas Edison, Charles Goodyear, and Elias Howe would be called PAEs or patent trolls today. In fact, they and other patent owners made royalty demands against thousands of end users.

Congress should exercise restraint when it is being asked to enact systemic legislative or regulatory changes on the basis of pejorative labels that would lead us to condemn or discriminate against classic innovators like Edison who have contributed immensely to America’s innovation economy.

Conclusion

In conclusion, the benefits or costs of patent licensing to the innovation economy is an important empirical and policy question, but systemic changes to the patent system should not be based on rhetoric, anecdotes, invalid studies, and incorrect claims about the historical and economic significance of patent licensing

As former PTO Director David Kappos stated last week in his testimony before the House Judiciary Committee: “we are reworking the greatest innovation engine the world has ever known, almost instantly after it has just been significantly overhauled. If there were ever a case where caution is called for, this is it.”

Thank you.