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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.

Last month the Wall Street Journal raised the specter of an antitrust challenge to the proposed Jos. A. Bank/Men’s Warehouse merger.

Whether a challenge is forthcoming appears to turn, of course, on market definition:

An important question in the FTC’s review will be whether it believes the two companies compete in a market that is more specialized than the broad men’s apparel market. If the commission concludes the companies do compete in a different space than retailers like Macy’s, Kohl’s and J.C. Penney, then the merger partners could face a more-difficult government review.

You’ll be excused for recalling that the last time you bought a suit you shopped at Jos. A. Bank and Macy’s before making your purchase at Nordstrom Rack, and for thinking that the idea of a relevant market comprising Jos. A. Bank and Men’s Warehouse to the exclusion of the others is absurd.  Because, you see, as the article notes (quoting Darren Tucker),

“The FTC sometimes segments markets in ways that can appear counterintuitive to the public.”

“Ah,” you say to yourself. “In other words, if the FTC’s rigorous econometric analysis shows that prices at Macy’s don’t actually affect pricing decisions at Men’s Warehouse, then I’d be surprised, but so be it.”

But that’s not what he means by “counterintuitive.” Rather,

The commission’s analysis, he said, will largely turn on how the companies have viewed the market in their own ordinary-course business documents.

According to this logic, even if Macy’s does exert pricing pressure on Jos. A Bank, if Jos. A. Bank’s business documents talk about Men’s Warehouse as its only real competition, or suggest that the two companies “dominate” the “mid-range men’s apparel market,” then FTC may decide to challenge the deal.

I don’t mean to single out Darren here; he just happens to be who the article quotes, and this kind of thinking is de rigeur.

But it’s just wrong. Or, I should say, it may be descriptively accurate — it may be that the FTC will make its enforcement decision (and the court would make its ruling) on the basis of business documents — but it’s just wrong as a matter of economics, common sense, logic and the protection of consumer welfare.

One can’t help but think of the Whole Foods/Wild Oats merger and the FTC’s ridiculous “premium, natural and organic supermarkets” market. As I said of that market definition:

In other words, there is a serious risk of conflating a “market” for business purposes with an actual antitrust-relevant market. Whole Foods and Wild Oats may view themselves as operating in a different world than Wal-Mart. But their self-characterization is largely irrelevant. What matters is whether customers who shop at Whole Foods would shop elsewhere for substitute products if Whole Food’s prices rose too much. The implicit notion that the availability of organic foods at Wal-Mart (to say nothing of pretty much every other grocery store in the US today!) exerts little or no competitive pressure on prices at Whole Foods seems facially silly.

I don’t know for certain what an econometric analysis would show, but I would indeed be shocked if a legitimate economic analysis suggested that Jos. A. Banks and Men’s Warehouse occupied all or most of any relevant market. For the most part — and certainly for the marginal consumer — there is no meaningful difference between a basic, grey worsted wool suit bought at a big department store in the mall and a similar suit bought at a small retailer in the same mall or a “warehouse” store across the street. And the barriers to entry in such a market, if it existed, would be insignificant. Again, what I said of Whole Foods/Wild Oats is surely true here, too:

But because economically-relevant market definition turns on demand elasticity among consumers who are often free to purchase products from multiple distribution channels, a myopic focus on a single channel of distribution to the exclusion of others is dangerous.

Let’s hope the FTC gets it right this time.

Earlier this month New Jersey became the most recent (but likely not the last) state to ban direct sales of automobiles. Although the rule nominally applies more broadly, it is directly aimed at keeping Tesla Motors (or at least its business model) out of New Jersey. Automobile dealers have offered several arguments why the rule is in the public interest, but a little basic economics reveals that these arguments are meritless.

Today the International Center for Law & Economics sent an open letter to New Jersey Governor Chris Christie, urging reconsideration of the regulation and explaining why the rule is unjustified — except as rent-seeking protectionism by independent auto dealers.

The letter, which was principally written by University of Michigan law professor, Dan Crane, and based in large part on his blog posts here at Truth on the Market (see here and here), was signed by more than 70 economists and law professors.

As the letter notes:

The Motor Vehicle Commission’s regulation was aimed specifically at stopping one company, Tesla Motors, from directly distributing its electric cars. But the regulation would apply equally to any other innovative manufacturer trying to bring a new automobile to market, as well. There is no justification on any rational economic or public policy grounds for such a restraint of commerce. Rather, the upshot of the regulation is to reduce competition in New Jersey’s automobile market for the benefit of its auto dealers and to the detriment of its consumers. It is protectionism for auto dealers, pure and simple.

The letter explains at length the economics of retail distribution and the misguided, anti-consumer logic of the regulation.

The letter concludes:

In sum, we have not heard a single argument for a direct distribution ban that makes any sense. To the contrary, these arguments simply bolster our belief that the regulations in question are motivated by economic protectionism that favors dealers at the expense of consumers and innovative technologies. It is discouraging to see this ban being used to block a company that is bringing dynamic and environmentally friendly products to market. We strongly encourage you to repeal it, by new legislation if necessary.

Among the letter’s signatories are some of the country’s most prominent legal scholars and economists from across the political spectrum.

Read the letter here:

Open Letter to New Jersey Governor Chris Christie on the Direct Automobile Distribution Ban

An occasional reader brought to our attention a bill that is fast making its way through the U.S. House Committee on Financial Services. The Small Company Disclosure Simplification Act (H.R. 4167) would exempt emerging growth companies and companies with annual gross revenue less than $250 million from using the eXtensible Business Reporting Language (XBRL) structure data format currently required for SEC filings. This would effect roughly 60% of publicly listed companies in the U.S.

XBRL makes it possible to easily extract financial data from electronic SEC filings using automated computer programs. Opponents of the bill (most of whom seem to make their living using XBRL to sell information to investors or assisting filing companies comply with the XBRL requirement) argue the bill will create a caste system of filers, harm the small companies the bill is intended to help, and harm investors (for example, see here and here). On pretty much every count, the critics are wrong. Here’s a point-by-point explanation of why:

1) Small firms will be hurt because they will have reduced access to capital markets because their data will be less accessible. — FALSE
The bill doesn’t prohibit small firms from using XBRL, it merely gives them the option to use it or not. If in fact small companies believe they are (or would be) disadvantaged in the market, they can continue filing just as they have been for at least the last two years. For critics to turn around and argue that small companies may choose to not use XBRL simply points out the fallacy of their claim that companies would be disadvantaged. The bill would basically give business owners and management the freedom to decide whether it is in fact in the company’s best interest to use the XBRL format. Therefore, there’s no reason to believe small firms will be hurt as claimed.

Moreover, the information disclosed by firms is no different under the bill–only the format in which it exists. There is no less information available to investors, it just makes it little less convenient to extract–particularly for the information service companies whose computer systems rely on XBRL to gather they data they sell to investors. More on this momentarily.

2) The costs of the current requirement are not as large as the bill’s sponsors claims.–IRRELEVANT AT BEST
According to XBRL US, an XBRL industry trade group, the cost of compliance ranges from $2,000 for small firms up to $25,000–per filing (or $8K to $100K per year). XBRL US goes on to claim those costs are coming down. Regardless whether the actual costs are the “tens of thousands of dollars a year” that bill sponsor Rep. Robert Hurt (VA-5) claims, the point is there are costs that are not clearly justified by any benefits of the disclosure format.

Moreover, if costs are coming down as claimed, then small businesses will be more likely to voluntarily use XBRL. In fact, the ability of small companies to choose NOT to file using XBRL will put competitive pressure on filing compliance companies to reduce costs even further in order to attract business, rather than enjoying a captive market of companies that have no choice.

3) Investors will be harmed because they will lose access to small company data.–FALSE
As noted above,investors will have no less information under the bill–they simply won’t be able to use automated programs to extract the information from the filings. Moreover, even if there was less information available, information asymmetry has long been a part of financial markets and markets are quite capable of dealing with such information asymmetry effectively in how prices are determined by investors and market-makers.  Paul Healy and Krishna Palepu (2001) provide an overview of the literature that shows markets are not only capable, but have an established history, of dealing with differences in information disclosure among firms. If any investors stand to lose, it would be current investors in small companies whose stocks could conceivably decrease in value if the companies choose not to use XBRL. Could. Conceivably. But with no evidence to suggest they would, much less that the effects would be large. To the extent large block holders and institutional investors perceive a potential negative effect, those investors also have the ability to influence management’s decision on whether to take advantage of the proposed exemption or to keep filing with the XBRL format.

The other potential investor harm critics point to with alarm is the prospect that small companies would be more likely and better able to engage in fraudulent reporting because regulators will not be able to as easily monitor the reports. Just one problem: the bill specifically requires the SEC to assess “the benefits to the Commission in terms of improved ability to monitor securities markets” of having the XBRL requirement. That will require the SEC to actively engage in monitoring both XBRL and non-XBRL filings in order to make that determination. So the threat of rampant fraud seems a tad bit overblown…certainly not what one critic described as “a massive regulatory loophole that a fraudulent company could drive an Enron-sized truck through.”

In the end, the bill before Congress would do nothing to change the kind of information that is made available to investors. It would create a more competitive market for companies who do choose to file using the XBRL structured data format, likely reducing the costs of that information format not only for small companies, but also for the larger companies that would still be required to use XBRL. By allowing smaller companies the freedom to choose what technical format to use in disclosing their data, the cost of compliance for all companies can be reduced. And that’s good for investors, capital formation, and the global competitiveness of US-based stock exchanges.

Last summer I blogged here at TOTM about the protectionist statutes designed to preempt direct distribution of Tesla cars that are proliferating around the country. This week, New Jersey’s Motor Vehicle Commission voted to add New Jersey to the list of states bowing to the politically powerful car dealers’ lobby.

Yesterday, I was on Bloomberg’s Market Makers show with Jim Appleton, the president of the New Jersey Coalition of Automotive Retailers. (The clip is here). Mr. Appleton advanced several “very interesting” arguments against direct distribution of cars, including that we already regulate everything else from securities sales to dogs and cats, so why not regulate car sales as well. The more we regulate, the more we should regulate. Good point. I’m stumped. But moving on, Mr. Appleton also argued that this particular regulation is necessary for actual reasons, and he gave two.

First, he argued that Tesla has a monopoly and that the direct distribution prohibition would create price competition. But, of course, Tesla does not have anything like a monopoly. A point that Mr. Appleton repeated three times over the course of our five minutes yesterday was that Tesla’s market share in New Jersey is 0.1%. Sorry, not a monopoly.

Mr. Appleton then insisted that the relevant “monopoly” is over the Tesla brand. This argument misunderstands basic economics. Every seller has a “monopoly” in its own brand to the same extent as Mr. Appleton has a “monopoly” in the tie he wore yesterday. No one but Tesla controls the Tesla brand, and no one but Mr. Appleton controls his tie. But, as economists have understood for a very long time, it would be absurd to equate monopoly power in an economic sense with the exclusive legal right to control something. Otherwise, every man, woman, child, dog, and cat is a monopolist over a whole bunch of things. The word monopoly can only make sense as capturing the absence of rivalry between sellers of different brands. A seller can have monopoly power in its brand, but only if there are not other brands that are reasonable substitutes. And, of course, there are many reasonable substitutes for Teslas.

Nor will forcing Tesla to sell through dealers create “price competition” for Teslas to the benefit of consumers. As I explained in my post last summer, Tesla maximizes its profits by minimizing its cost of distribution. If dealers can perform that function more efficiently than Tesla, Tesla has every incentive to distribute through dealers. The one thing Tesla cannot do is increase its profits by charging more for the retail distribution function than dealers would charge. Whatever the explanation for Tesla’s decision to distribute directly may be, it has nothing to do with charging consumers a monopoly price for the distribution of Teslas.

Mr. Appleton’s second argument was that the dealer protection laws are necessary for consumer safety. He then pointed to the news that GM might have prevented accidents taking 12 lives if it had recalled some of its vehicles earlier than it eventually did. But of course all of this occurred while GM was distributing through franchised dealers. To take Mr. Appleton’s logic, I should have been arguing that distribution through franchised dealers kills people.

Mr. Appleton then offered a concrete argument on car safety. He said that, to manufacturers, product recalls are a cost whereas, to dealers, they are an opportunity to earn income. But that argument is also facially absurd. Dealers don’t make the decision to issue safety recalls. Those decisions come from the manufacturer and the National Highway Traffic Safety Administration. Dealers benefit only incidentally.

The direct distribution laws have nothing to do with enhancing price competition or car safety. They are protectionism for dealers, pure and simple. At a time when Chris Christie is trying to regain credibility with New Jersey voters in general, and New Jersey motorists in particular, this development is a real shame.

On Wednesday, the U.S. Supreme Court heard oral argument in Halliburton v. Erica P. John Fund, a case that could drastically alter the securities fraud landscape.  Here are a few thoughts on the issues at stake in the case and a cautious prediction about how the Court will rule.

First, some quick background for the uninitiated.  The broadest anti-fraud provision of the securities laws, Section 10(b) of the 1934 Securities Exchange Act, forbids the use of “any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe….”  The Commission’s Rule 10b-5, then, makes it illegal “to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”

Although Section 10(b) doesn’t expressly entitle victims of securities fraud to sue for damages, the Supreme Court long ago inferred a private right of action to enforce the provision.  The elements of that judicially created private right of action are: (1) a material misrepresentation or omission by the defendant, (2) scienter (i.e., mental culpability worse than mere negligence) on the part of the defendant, (3) a connection between the misrepresentation or omission and the purchase or sale of a security, (4) the plaintiff’s reliance upon the misrepresentation or omission, (5) economic loss by the plaintiff, and (6) loss causation (i.e., the fraud, followed by revelation of the truth, was the proximate cause of the plaintiff’s investment loss).

For most individual investors, the economic loss resulting from any instance of securities fraud (and, thus, the potential recovery) is not enough to justify the costs of bringing a lawsuit.  Accordingly, 10b-5 suits seem like an appropriate context for class actions.  The elements of the judicially created cause of action, however, make class certification difficult.  That is because most securities fraud class actions would proceed under Federal Rule of Civil Procedure 23(b)(3), which requires that common issues of law or fact in all the plaintiffs’ cases predominate over plaintiff-specific issues.  Because the degree to which any individual investor relied upon a misrepresentation (element 4) requires proof of lots of investor-specific facts (How did you learn of the misrepresentation?, How did it influence your investment decision?, etc.), the reliance element would seem to preclude Rule 10b-5 class actions.

In Basic v. Levinson, a 1988 Supreme Court decision from which three justices were recused, a four-justice majority endorsed a doctrine that has permitted Rule 10b-5 class actions to proceed, despite the reliance element.  The so-called “fraud on the market” doctrine creates a rebuttable presumption that an investor who traded in an efficient stock market following a fraudulent disclosure (but before the truth was revealed) “relied” on that disclosure, even if she didn’t see or hear about it.  The theoretical basis for the fraud on the market doctrine is the semi-strong version of the Efficient Capital Markets Hypothesis (ECMH), which posits that securities prices almost instantly incorporate all publicly available information about the underlying company, making it impossible to earn above-normal returns by engaging in “fundamental analysis” (i.e., study of publicly available information about a listed company).  The logic of the fraud on the market doctrine is that publicly available misinformation affects a security’s price, upon which an investor normally relies when she makes her investment decision.  Thus, any investor who makes her investment decision on the basis of the stock’s price “relies” on the “ingredients” of that price, including the misinformation at issue.

In light of this logic, the Basic Court reasoned that a defendant could rebut the presumption of reliance by severing either the link between the misinformation and the stock’s price or the link between the stock’s price and the investor’s decision.  To sever the former link, the defendant would need to show that key market makers were privy to the truth, so that the complained of lie could not have affected the market price of the stock (in other words, there was “truth on the market”…great name for a blog, no?).  To sever the latter link, the defendant would need to show that the plaintiff investor made her investment decision for some reason unrelated to the stock’s price—say, because she needed to divest herself of the stock for political reasons.

Basic thus set up a scheme in which the class plaintiff bears the burden of establishing that the stock at issue traded in an efficient market.  If she does so, her (and similarly situated class members’) reliance on the misinformation at issue is presumed.  The defendant then bears the burden of rebutting the presumption by showing either that the misrepresentation did not give rise to a price distortion (probably because the truth was on the market) or that the individual investor would have traded even if she knew the statement was false (i.e., her decision was not based on the stock’s price).

The Halliburton appeal presents two questions.  First, should the Court overrule Basic and jettison the rebuttable presumption of reliance when the stock at issue is traded in an efficient market.  Second, at the class certification stage, should the defendant be permitted to prevent the reliance presumption from arising by presenting evidence that the alleged misrepresentation failed to distort the market price of the stock at issue.

With respect to the first question, the Court could go three ways.  First, it could maintain the status quo rule that 10b-5 plaintiffs, in order to obtain the reliance presumption, must establish only that the stock at issue was traded in an efficient market.  Second, it could overrule Basic wholesale and hold that a 10b-5 plaintiff must establish actual, individualized reliance (i.e., show that she knew of the misrepresentation and that it influenced her investment decision).  Third, the Court could tweak Basic by holding that plaintiffs may avail themselves of the presumption of reliance only if they establish, at the class certification stage, that the complained of
misrepresentation actually distorted the market price of the stock at issue.

My guess, which I held before oral argument and seems consistent with the justices’ questioning on Wednesday, is that the Court will take the third route.  There are serious problems with the status quo.  First, it rests squarely upon the semi-strong version of the ECMH, which has come under fire in recent years.  While no one doubts that securities prices generally incorporate publicly available information, and very quickly, a number of studies purporting to document the existence of arbitrage opportunities have challenged the empirical claim that every bit of publicly available information is immediately incorporated into the price of every security traded in an efficient market.  Indeed, the winners of this year’s Nobel Prize in Economics split on this very question.   I doubt this Supreme Court will want to be perceived as endorsing a controversial economic theory, especially when doing so isn’t necessary to maintain some sort of reliance presumption (given the third possible holding discussed above).

A second problem with the status quo is that it places an unreasonable burden on courts deciding whether to certify a class.  The threshold question for the fraud on the market presumption—is the security traded in an efficient market?—is just too difficult for non-specialist courts.  How does one identify an “efficient market”?  One court said the relevant factors are:  “(1) the stock’s average weekly trading volume; (2) the number of securities analysts that followed and reported on the stock; (3) the presence of market makers and arbitrageurs; (4) the company’s eligibility to file a Form S-3 Registration Statement; and (5) a cause-and-effect relationship, over time, between unexpected corporate events or financial releases and an immediate response in stock price.”  Others have supplemented these so-called “Cammer factors” with a few others: market capitalization, the bid/ask spread, float, and analyses of autocorrelation.  No one can say, though, how each factor should be assessed (e.g., How many securities analysts must follow the stock? How much autocorrelation is permissible?  How large may the bid-ask spread be?).  Nor is there guidance on how to balance factors when some weigh in favor of efficiency and others don’t.  It’s a crapshoot.

The status quo approach of presuming investor reliance if the plaintiff establishes an efficient market for the company’s stock is also troubling because the notion of a “market” for any single company’s stock is theoretically unsound.  An economic market consist of all products that are, from a buyer’s perspective, reasonably interchangeable.  For example, Evian bottled water (spring water from the Alps) is a very close substitute for Fiji water (spring water from the Fiji Islands) and is probably in the same product market.  From an investor’s perspective, there are scores of close substitutes for the stock of any particular company.  Such substitutes would include all other stocks that offer the same package of financial attributes (risk, expected return, etc.).  It makes little sense, then, to speak of a “market” consisting of a single company’s stock, and basing the presumption of reliance on establishment of an “efficient market” in one company’s stock is somewhat nonsensical.

With respect to the second possible route for the Halliburton Court—overturning Basic in its entirety and requiring individualized proof of actual reliance—proponents emphasize that the private right of action to enforce Section 10(b) and Rule 10b-5 is judicially created.  The Supreme Court now disfavors implied rights of action and, to avoid stepping on Congress’s turf, requires that they stick close to the statute at issue.  In particular, the Court has said that determining the elements of a private right of action requires “historical reconstruction.”  With respect to the Rule 10b-5 action, the Court tries “to infer how the 1934 Congress would have addressed the issue had the 10b-5 action been included as an express provision of the 1934 Act,” and to do that, it consults “the express causes of action” in the Act and borrows from the “most analogous” one.  In this case, that provision is Section 18(a), which is the only provision in the Exchange Act authorizing damages actions for misrepresentations affecting secondary, aftermarket trading (i.e., trading after a public offering of the stock at issue).  Section 18(a) requires a plaintiff to establish actual “eyeball” reliance—i.e., that she bought the security with knowledge of the false statement and relied upon it in making her investment decision.  There is thus a powerful legal argument in favor of a full-scale overturning of Basic.

As much as I’d like for the Court to take that route (because I believe Rule 10b-5 class actions create far greater social cost than benefit), I don’t think the Court will go there.  Overruling Basic to require eyeball reliance in Rule 10b-5 actions would be perceived as an activist, “pro-business” decision:  activist because Congress has enacted significant legislation addressing Rule 10b-5 actions and has left the fraud on the market doctrine untouched, and pro-business because it would insulate corporate managers from 10b-5 class actions.

Now, both of those characterizations are wrong.  The chief post-Basic legislation involving Rule 10b-5, the 1995 Private Securities Litigation Reform Act, specifically stated (in Section 203) that “[n]othing in this Act shall be deemed to … ratify any implied private right of action.”  As Justices Alito and Scalia emphasized at oral argument, the PSLRA expressly declined to put a congressional imprimatur on the judicially created Rule 10b-5 cause of action, so a Court decision modifying Rule 10b-5’s elements would hardly be “activist.” Nor would the decision be “pro-business” and “anti-investor.”  The fact is, the vast majority of Rule 10b-5 class actions are settled on terms where the corporation pays the bulk of the settlement, which largely goes to class counsel.  The corporation, of course, is spending investors’ money.  All told, then, investors as a class pay a lot for, and get very little from, Rule 10b-5 class actions.  A ruling eviscerating such actions would better be characterized as pro-investor.

Sadly, our financially illiterate news media cannot be expected to understand all this and would, if Basic were overturned, fill the newsstands and airwaves with familiar stories of how the Roberts Court continues on its activist, pro-business rampage.  And even more sadly, at least one key justice whose vote would be needed for a Basic overruling, has proven himself to be exceedingly concerned with avoiding the appearance of “activism.”  A wholesale overruling of Basic, then, is unlikely.

That leaves the third route, modifying Basic to require that class plaintiffs first establish a price distortion resulting from the complained of misrepresentation.  I have long suspected that this is where the Court will go, and the justices’ questioning on Wednesday suggests this is how many (especially Chief Justice Roberts and Justice Kennedy) are leaning.  From the Court’s perspective, there are several benefits to this approach.

First, it would allow the Court to avoid passing judgment on the semi-strong ECMH.  The status quo approach—prove an efficient market and we’ll presume reliance because of an inevitable price effect—really seems to endorse the semi-strong ECMH.  An approach requiring proof of price distortion, by contrast, doesn’t.  It may implicitly assume that most pieces of public information are instantly incorporated into securities prices, but no one really doubts that.

Second, the third route would substitute a fairly manageable inquiry (Did the misrepresentation occasion a price effect?) for one that is both difficult and theoretically problematic (Is the market for the company’s stock efficient?).

Third, the approach would allow the Court to eliminate a number of the most meritless securities fraud class actions without appearing overly “activist” and “pro-business.”  If class plaintiffs can’t show a price effect from a complained of misrepresentation or omission, then their claim is really frivolous and ought to go away immediately.  The status quo would permit certification of the class, despite the absence of a price effect, as long as class counsel could demonstrate an efficient market using the amorphous and unreliable factors set forth above.  And once the class is certified, the plaintiffs have tons of settlement leverage, even when they don’t have much of a claim.  In short, the price distortion criterion is a far better screen than the market efficiency screen courts currently utilize.  For all these reasons, I suspect the Court will decide not to overrule Basic but to tweak it to require a threshold showing of price distortion.

If it does so, then the second question at issue in Halliburton—may the defendant, at the class certification stage, present evidence of an absence of price distortion?—goes away.  If the plaintiff must establish price distortion to attain class certification, then due process would require that the defendant be allowed to poke holes in the plaintiff’s certification case.

So that’s my prediction on Halliburton.  We shall see.  Whatever the outcome, we’ll have lots to discuss in June.

Once again, my constitutional law professor has embarrassed me with his gross misunderstanding of the U.S. Constitution.  First, he insisted that it would be “unprecedented” for the U.S. Supreme Court to overturn a statute enacted by a “democratically elected Congress.”  Seventh-grade Civics students know that’s not right, but Mr. Obama’s misstatement did have its intended effect:  It sent a clear signal that the President and his lackeys would call into question the legitimacy of the Supreme Court should it invalidate the Affordable Care Act (ACA).  Duly warned, Chief Justice Roberts changed his vote in NFIB v. Sebelius to save the Court from whatever institutional damage Mr. Obama would have inflicted.

Now President Obama – who chastised his predecessor for offending the constitutional order and insisted that he, a former constitutional law professor, would never stoop so low – has both violated his oath of office and flouted a key constitutional feature, the separation of powers.  I’m speaking of the President’s “administrative fix” to the ACA.  That “fix” consists of a presidential order not to enforce the Act’s minimum coverage provisions, a move that President Obama says will allow insurance companies to continue offering ACA non-compliant policies to those previously enrolled in them if the companies wish to do so and are able to obtain permission at the state level.

This is, of course, nothing more than a transparent attempt to shift blame for the millions of recently canceled policies.  Having priced their more generous ACA-compliant policies on the assumption that there would be an influx of healthy customers now covered by high-deductible, non-compliant policies, insurance companies would shoot themselves in the foot by accepting Mr. Obama’s generous “offer.”  Moreover, state insurance commissioners, aware of the adverse selection likely to result from this last-minute rule change, are unlikely to give their blessing.  (Indeed, several have balked – including the D.C. insurance commissioner, who was promptly fired.)

But putting aside the fact that the administrative fix won’t work, the main problem with it is that it is blatantly unconstitutional.  The Constitution divides power between the three branches of government.  Article I grants to the Congress “all legislative Powers,” including “Power to lay and collect Taxes.”  Article II then directs the President to “take Care that the laws be faithfully executed.” With his administrative fix, President Obama has essentially said, “I promise not to execute the law Congress passed.”

Moreover, the President went further to say, “I promise not to collect a tax the Congress imposed.”  Remember that the penalty for failure to carry ACA-compliant insurance is, for constitutional purposes, a tax.  That was the central holding of last summer’s Obamacare decision, NFIB v. Sebelius.  When the President assured victims of insurance cancellations that he would turn a blind eye to the law and allow their insurers to continue to offer canceled policies, he also implied that he would order his administration not to collect the taxes owed by those in ACA-noncompliant policies.  Indeed, this matter was clarified in the letter the Department of Health and Human Services sent to state insurance commissioners notifying them of the Obama Administration’s decision not to enforce the law as written.  That letter stated that the Department of the Treasury, which is charged (through the IRS) with collecting the ACA’s penalties/taxes, “concur[red] with the transitional relief afforded in this document.”  That means the IRS, pursuant to the President’s order, is promising not to collect a tax the Congress has imposed.

This, my friends, is a major disruption of the constitutional order.  If the President of the United States may simply decide not to collect taxes imposed by the branch of government that has been given exclusive “Power to lay and collect Taxes,” the whole Constitution is thrown off-kilter.  Any time a president wanted to favor some individuals, firms, or industries, he wouldn’t need to go to Congress for approval.  No, he could just order his IRS not to collect taxes from those folks.  Can’t get Congress to approve subsidies for green technologies?  No worries.  Just order your IRS not to collect taxes from firms in that sector.  Or maybe even order a refundable tax credit.  You think Congress has enacted job-killing regulations on an industry?  Just invoke your enforcement discretion and ignore those rules.  Whew!  This sure makes things easier.

President Obama twice promised, under oath, to “take Care that the Laws be faithfully executed.”  Unfortunately, he also rammed through a terrible law.  Our Constitution now gives him the option to enforce the enacted law and pay the political price, or seek Congress’s assistance to change the law.  On the particular matter at issue here, Congress is willing to help the President out.  On Friday, the House of Representatives voted to amend the law to allow insurance companies to continue to offer ACA non-compliant policies.  Mr. Obama doesn’t like some details of the legislative fix he’s been offered.  Unfortunately for him, though, he’s not a king.  He has to work within the constitutional order.

At least, that’s what I thought I learned in constitutional law.

Over at the Center for the Protection of Intellectual Property (CPIP), Mark Schultz has an important blog posting on the Mercatus Center‘s recent launch of its new copyright piracy website, piracydata.org.  The launch of this website has caused a bit of a tempest in a teapot with a positive report on it in the Washington Post and with a report in the Columbia Journalism Review pointing out problems in its data and errors in its claims.  (It is a bit ironic that a libertarian organization is having trouble with the launch of a website at the same time that there is similar reporting on troubles of the launch of another website on the opposite side of the political spectrum, Obamacare.)

Professor Schultz, who is a Senior Scholar at CPIP and a law professor at Southern Illinois University, makes many important points in his blog posting (too many to recount here).  One of his more important identifications is that the piracydata.org website reflects an unfortunate tendency among libertarian IP skeptics, who seem to fall victim to an error that they often identify in leftist critiques of the free market, at least on non-IP issues.  That is, some libertarian IP skeptics seem all to quick to deduce conclusions about actual, real-world business models from solely theoretical knowledge about what they think these business models should be in some “ideal” world.

Professor Schultz also identifies that, despite protestations to the contrary, Jerry Brito has explicitly framed his website as a “blame the victim” defense of copyright piracy — stating explicitly on Twitter that “Hollywood should blame itself for its piracy problems.” Consistent with such statements, of course, conventional wisdom has quickly gelled around the piracydata.org website that it is in fact a condemnation of the creative industries’ business models.  (Professor Schultz backs up this point with many references and links, including a screen grab of Jerry’s tweet.)

Professor Schultz ultimately concludes his important essay as follows:

perhaps the authors should simply dispense with the pretext. All too often, we see arguments such as this that say ‘I think copyright is important and abhor piracy, BUT . . . ‘ And, after the “but” comes outrage at most any attempt by creators to enforce their rights and protect their investment. Or, as in this case, advice that excuses piracy and counsels surrender to piracy as the only practical way forward. Perhaps it would be less hypocritical for such commentators to admit that they are members of the Copyleft. While I think that it’s a terribly misguided and unfortunate position, it is all too respectable in libertarian circles these days. See the debate in which I participated earlier this year in Cato Unbound.

In any event, however, how about a little more modesty and a little more respect for copyright owners? In truth, the “content” industry leaders I’ve met are, as I’ve told them, way smarter than the Internet says they are. They are certainly smarter about their business than any policy analysts or other Washingtonians I’ve met.

The movie industry knows these numbers very well and knows about the challenges imposed by its release windows. They know their business better than their critics. All sorts of internal, business, and practical constraints may keep them from fixing their problems overnight, but it’s not a lack of will or insight that’s doing it. If you love the free market, then perhaps it’s time to respect the people with the best information about their property and the greatest motivation to engage in mutually beneficial voluntary exchanges.

Or you can just contribute to the mountain of lame excuses for piracy that have piled up over the last decade.

This is a compelling call to arms  for some libertarians doing policy work in the creative industries to take more seriously in practice their theoretical commitments to private ordering and free enterprise.

As the blogging king (Instapundit) is wont to say: Read the whole thing.

The debates over mobile spectrum aggregation and the auction rules for the FCC’s upcoming incentive auction — like all regulatory rent-seeking — can be farcical. One aspect of the debate in particular is worth highlighting, as it puts into stark relief the tendentiousness of self-interested companies making claims about the public interestedness of their preferred policies: The debate over how and whether to limit the buying and aggregating of lower frequency (in this case 600 MHz) spectrum.

A little technical background is in order. At its most basic, a signal carried in higher frequency spectrum doesn’t travel as well as a signal carried in lower frequency spectrum. The higher the frequency, the closer together cell towers need to be to maintain a good signal.

600MHz is relatively low frequency for wireless communications. In rural areas it is helpful in reducing infrastructure costs for wide area coverage because cell towers can be placed further apart and thus fewer towers must be built. But in cities, population density trumps frequency, and propagation range is essentially irrelevant for infrastructure costs. In other words, it doesn’t matter how far your signal will travel if congestion alleviation demands you build cell towers closer together than even the highest frequency spectrum requires anyway. The optimal — nay, the largest usable — cell radius in urban and suburban areas is considerably smaller than the sort of cell radius that low frequency spectrum allows for.

It is important to note, of course, that signal distance isn’t the only propagation characteristic imparting value to lower frequency spectrum; in particular, it is also valuable even in densely populated settings for its ability to travel through building walls. That said, however, the primary arguments made in favor of spreading the 600 MHz wealth — of effectively subsidizing its purchase by smaller carriers — are rooted in its value in offering more efficient coverage in less-populated areas. Thus the FCC has noted that while there may be significant infrastructure cost savings associated with deploying lower frequency networks in rural areas, this lower frequency spectrum provides little cost advantage in urban or suburban areas (even though, as noted, it has building-penetrating value there).

It is primarily because of these possible rural network cost advantages that certain entities (the Department of Justice, Free Press, the Competitive Carriers Association, e.g.) have proposed that AT&T and Verizon (both of whom have significant lower frequency spectrum holdings) should be restricted from winning “too much” spectrum in the FCC’s upcoming 600 MHz incentive auctions. The argument goes that, in order to ensure national competition — that is, to give other companies financial incentive to build out their networks into rural areas — the auction should be structured to favor Sprint and T-Mobile (both of whose spectrum holdings are mostly in the upper frequency bands) as awardees of this low-frequency spectrum, at commensurately lower cost.

Shockingly, T-Mobile and Sprint are on board with this plan.

So, to recap: 600MHz spectrum confers cost savings when used in rural areas. It has much less effect on infrastructure costs in urban and suburban areas. T-Mobile and Sprint don’t have much of it; AT&T and Verizon have lots. If we want T-Mobile and Sprint to create the competing national networks that the government seems dead set on engineering, we need to put a thumb on the scale in the 600MHz auctions. So they can compete in rural areas. Because that’s where 600MHz spectrum offers cost advantages. In rural areas.

So what does T-Mobile plan to do if it wins the spectrum lottery? Certainly not build in rural areas. As Craig Moffett notes, currently “T-Mobile’s U.S. network is fast…but coverage is not its strong suit, particularly outside of metro areas.” And for the future? T-mobile’s breakneck LTE coverage ramp up since the failed merger with AT&T is expected to top out at 225 million people, or the 71% of consumers living in the most-populated areas (it’s currently somewhere over 200 million). “Although sticking to a smaller network, T-Mobile plans to keep increasing the depth of its LTE coverage” (emphasis added). Depth. That means more bandwidth in high-density areas. It does not mean broader coverage. Obviously.

Sprint, meanwhile, is devoting all of its resources to playing LTE catch-up in the most-populated areas; it isn’t going to waste valuable spectrum resources on expanded rural build out anytime soon.

The kicker is that T-Mobile relies on AT&T’s network to provide its urban and suburban customers with coverage (3G) when they do roam into rural areas, taking advantage of a merger break-up provision that gives it roaming access to AT&T’s 3G network. In other words, T-Mobile’s national network is truly “national” only insofar as it piggybacks on AT&T’s broader coverage. And because AT&T will get the blame for congestion when T-Mobile’s customers roam onto its network, the cost to T-Mobile of hamstringing AT&T’s network is low.

The upshot is that T-Mobile seems not to need, nor does it intend to deploy, lower frequency spectrum to build out its network in less-populated areas. Defenders say that rigging the auction rules to benefit T-Mobile and Sprint will allow them to build out in rural areas to compete with AT&T’s and Verizon’s broader networks. But this is a red herring. They may get the spectrum, but they won’t use it to extend their coverage in rural areas; they’ll use it to add “depth” to their overloaded urban and suburban networks.

But for AT&T the need for additional spectrum is made more acute by the roaming deal, which requires it to serve its own customers and those of T-Mobile.

This makes clear the reason underlying T‑Mobile’s advocacy for rigging the 600 MHz auction – it is simply so that T‑Mobile can acquire this spectrum on the cheap to use in urban and suburban areas, not so that it can deploy a wide rural network. And the beauty of it is that by hamstringing AT&T’s ability to acquire this spectrum, it becomes more expensive for AT&T to serve T‑Mobile’s own customers!

Two birds, one stone: lower your costs, raise your competitor’s costs.

The lesson is this: If we want 600 MHz spectrum to be used efficiently to provide rural LTE service, we should assume that the highest bidder will make the most valuable use of the spectrum. The experience of the relatively unrestricted 700 MHz auction in 2008 confirms this. The purchase of 700 MHz spectrum by AT&T and Verizon led to the US becoming the world leader in LTE. Why mess with success?

[Cross-posted at RedState]

Susan Crawford recently received the OneCommunity Broadband Hero Award for being a “tireless advocate for 21st century high capacity network access.” In her recent debate with Geoffrey Manne and Berin Szoka, she emphasized that there is little competition in broadband or between cable broadband and wireless, asserting that the main players have effectively divided the markets. As a result, she argues (as she did here at 17:29) that broadband and wireless providers “are deciding not to invest in the very expensive infrastructure because they are very happy with the profits they are getting now.” In the debate, Manne countered by pointing to substantial investment and innovation in both the wired and wireless broadband marketplaces, and arguing that this is not something monopolists insulated from competition do. So, who’s right?

The recently released 2013 Progressive Policy Institute Report, U.S. Investment Heroes of 2013: The Companies Betting on America’s Future, has two useful little tables that lend support to Manne’s counterargument.

skitch

The first shows the top 25 investors that are nonfinancial companies, and guess who comes in 1st, 2nd, 10th, 13th, and 17th place? None other than AT&T, Verizon Communications, Comcast, Sprint Nextel, and Time Warner, respectively.

skatch

And when the table is adjusted by removing non-energy companies, the ranks become 1st, 2nd, 5th, 6th, and 9th. In fact, cable and telecom combined to invest over $50.5 billion in 2012.

This high level of investment by supposed monopolists is not a new development. The Progressive Policy Institute’s 2012 Report, Investment Heroes: Who’s Betting on America’s Future? indicates that the same main players have been investing heavily for years. Since 1996, the cable industry has invested over $200 billion into infrastructure alone. These investments have allowed 99.5% of Americans to have access to broadband – via landline, wireless, or both – as of the end of 2012.

There’s more. Not only has there been substantial investment that has increased access, but the speeds of service have increased dramatically over the past few years. The National Broadband Map data show that by the end of 2012:

  • Landline service ≧ 25 megabits per second download available to 81.7% of households, up from 72.9% at the end of 2011 and 58.4% at the end of 2010
  • Landline service ≧ 100 megabits per second download available to 51.5% of households, up from 43.4% at the end of 2011 and only 12.9% at the end of 2010
  • ≧ 1 gigabit per second download available to 6.8% of households, predominantly via fiber
  • Fiber at any speed was available to 22.9% of households, up from 16.8% at the end of 2011 and 14.8% at the end of 2010
  • Landline broadband service at the 3 megabits / 768 kilobits threshold available to 93.4% of households, up from 92.8% at the end of 2011
  • Mobile wireless broadband at the 3 megabits / 768 kilobits threshold available to 94.1% of households , up from 75.8% at the end of 2011
  • Access to mobile wireless broadband providing ≧ 10 megabits per second download has grown to 87%, up from 70.6 percent at the end of 2011 and 8.9 percent at the end of 2010
  • Landline broadband ≧ 10 megabits download was available to 91.1% of households

This leaves only one question: Will the real broadband heroes please stand up?