I do not know David Brat and had never heard of him before he won the primary. I have looked at his Vita. However, I am bothered by seeing him called a free market economist and a Randian. Apparently one of the major issues distinguishing him from Mr. Cantor is Mr. Brat’s opposition to immigrants and immigration reform. I cannot understand how someone can be a free market economist and opposed to immigration reform. Our immigration laws are a major limitation on free exchange, and anyone who really favors free markets must be in favor of major reforms, including allowing those who are here illegally to legalize their status.
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On May 9, 2014, in Horne v. Department of Agriculture, the Ninth Circuit struck a blow against economic liberty by denying two California raisin growers’ efforts to recover penalties imposed against them by the U.S. Department of Agriculture (USDA). The growers’ heinous offense was their refusal to continue participating in a highly anticompetitive cartel. In order to understand this bizarre miscarriage of justice, which turns orthodox anti-cartel policy on its head, a bit of background is in order.
Perhaps the most serious affront to a sound consumer welfare-based American antitrust policy is the persistence of federal government-sponsored agricultural cartels. In a form of bureaucratic schizophrenia, while the Justice Department works hard to send private cartelists to jail, and grants leniency to informers who undermine cartels, the U.S. Agriculture Department (USDA) seeks to punish individuals who undercut USDA-sponsored cartels created pursuant to Agricultural Marketing Agreement Act marketing orders. Those orders establish antitrust-exempt government-approved frameworks under which private industry members restrict output and raise the price of specific crops, in the name of ensuring “orderly” markets. (Various scholars, such as Mario Loyola, have explored the public choice explanations for the private-public collusion that leads to marketing orders and other government-supported cartels.)
A particularly notorious USDA cartel is the California Raisin Marketing Order (“Raisin Order”), in operation since 1949, which establishes a Raisin Administrative Committee (“RAC”). The RAC is comprised almost entirely of self-interested raisin growers and packers (it is comprised of 47 growers and packers, plus a public member). The RAC sets annual raisin “reserve tonnage” requirements as a percentage of the overall crop, with the remainder comprising “free raisins.” “Reserve raisins” are diverted from the market but may be released when supplies are low. Under the Raisin Order, raisin producers convey their entire crop to raisin packer-distributors known as “handlers,” with producers receiving a pre-negotiated price for the free tonnage. Handlers sell free tonnage raisins on the open market, and divert the RAC-required percentage of each producer’s crop to the account of the RAC. The RAC tracks how many raisins each producer contributes to the reserve pool, and has a regulatory duty to sell them in a way that maximizes producer returns. The RAC finances its activities from reserve raisin sales proceeds, and disburses whatever net income remains to producers. Reserve raisins are diverted to “low value” markets, such as the export sector, while American consumers typically buy free raisins. The Raisin Order imposes substantial harm on American consumers: for example, in 2001 free raisins sold for $877.50 per ton compared to $250 per ton for reserve raisins, and the free raisins/reserve raisins price ration approached 10/1 in 1984 and 1991.
California raisin producers Marvin and Laura Horne sought to evade these cartel strictures by handling their own raisin crop, rather than selling it to traditional handlers, against whom the reserve requirement of the Raisin Order clearly operated. Similarly, by buying and handling other producers’ raisins for a per-pound fee, the Hornes believed that they could avoid the Raisin Order’s definition of “handler” with respect to those purchased raisins. A USDA judicial officer disagreed, finding the Hornes liable for numerous Order violations and fining them over $695,000, including an assessment of nearly $484,000 for the dollar value of the raisins not held in reserve.
The Hornes challenged this USDA order in federal district court, arguing that they were not “handlers” within the meaning of the Raisin Order and that the order violated the Fifth Amendment’s Takings Clause and the Eighth Amendment’s prohibition against excessive fines. The district court granted summary judgment for USDA on all counts. On appeal, the Ninth Circuit affirmed the application of the Raisin Order and the denial of the Eighth Amendment claim, but held that the Court of Federal Claims rather than the district court had jurisdiction over the takings claim. The U.S. Supreme Court granted certiorari on the jurisdictional issue only, holding that the Hornes could assert their takings claim in district court. The Supreme Court remanded for a determination of the merits of the takings claim, and on May 9 the Ninth Circuit, applying de novo review, affirmed the district court’s rejection of that claim.
The Ninth Circuit acknowledged that USDA linked a monetary exaction (the penalty imposed for failure to comply with the Raisin Order) to specific property (the reserved raisins) and that the Hornes faced a choice – give the RAC the raisins or face a penalty. Because the government did not literally seize raisins from the Holmes’ land or remove money from their bank account, the court held that the USDA’s action had to be analyzed as a potential regulatory taking. The court then noted that the Takings Clause affords less protection to personal property than to real property, and that the Hornes did not lose all economically valuable use of their property. The court asserted that the Hornes’ rights with respect to the reserved raisins were not extinguished because they retained a claim on certain future proceeds from reserved raisin sales (even though, as the Hornes pointed out, the “equitable distribution” of reserved sales might be zero). The court reasoned that even though the Hornes might not receive cash distributions in some years, the reserved raisins were not “permanently occupied,” and that the RAC’s diversion of reserved raisins inured to the Hornes’ benefit by stabilizing raisin prices. The court viewed the raisin diversion program as granting a conditional government benefit in exchange for an exaction. In short, by smoothing price fluctuations in the raisin industry, the Raisin Order made “market conditions predictable” and thereby bore a “sufficient nexus” to a legitimate interest the government sought to protect. (The court never asked why the reduction of consumer welfare and the imposition of deadweight losses through industry cartelization is a legitimate government interest.) Moreover, the RAC’s imposition of a reserve requirement on all producers was roughly proportional to the USDA’s market stabilizing goal as reflected in the Raisin Order. Thus, applying the nexus/proportionaliy test of Nollan v. California Coastal Commission and Dolan v. City of Tigard, the Ninth Circuit held that the application of the Marketing Order to the Hornes’ activities did not constitute a taking.
Stripped of its convoluted reasoning and highly selective application of Supreme Court precedents, the Ninth Circuit’s holding indicates that industrious and entrepreneurial individuals will not be allowed to avoid and thereby undermine agricultural cartels through creative commercial innovations. It means that individuals engaging in a legitimate business activity who wish not to contribute their product to a cartel that is imposed on them may suffer loss of their property, merely because the government approves of the cartel and wishes to protect it by punishing “cheaters.” But when the government is the ringmaster, odious cartels are miraculously transformed into praiseworthy citizens who promote the public interest by “stabilizing” markets.
Whatever the ultimate outcome of the Hornes’ legal saga, the Ninth Circuit’s crabbed analysis highlights the absurdity of imposing government financial exactions on private commercial conduct that unequivocally raises consumer welfare and enhances competition. The egregiousness of this conduct is amplified when the government penalizes a business for refusing to transfer some of its property to a third party (here, the RAC), without assurance of being compensated. Whether the business chooses to incur the penalty or instead accedes to the transfer, basic logic demonstrates that its property is being taken. Hopefully, future courts will keep this in mind and be willing to apply the Takings Clause to analogous scenarios.
If faced by a serious possibility of having to pay “just compensation” under the Takings Clause, the USDA may become less willing to sanction cartel avoiders through overly expansive interpretations of its agricultural marketing orders. That in turn could encourage additional businesses to seek creative ways to opt out of these arrangements. The end result could be the gradual weakening and ultimate dismantling of the marketing order framework. Even better, the USDA could choose to act unilaterally tomorrow and move to rescind marketing order regulations. (That might be asking too much, of course.)
We’re delighted to announce the newest addition to our blogging roster, Alden Abbott.
Alden recently joined the Heritage Foundation as Senior Fellow and Deputy Director of the Center for Legal and Judicial Studies. For two years ending in April 2014, he was Director, Global Patent Law and Competition Strategy at Blackberry.
Alden has been at the center of the US antitrust universe for most of his career. When he retired from the FTC in 2012, he had served as Deputy Director of the Office of International Affairs for three years. Before that he was Director of Policy and Coordination, FTC Bureau of Competition; Acting General Counsel, Department of Commerce; Chief Counsel, National Telecommunications and Information Administration; Senior Counsel, Office of Legal Counsel, DOJ; and Special Assistant to the Assistant Attorney General for Antitrust, DOJ.
Alden is also an Adjunct Professor at George Mason Law School, a member of the Leadership of the American Bar Association’s Antitrust Section, and a Non-Governmental Advisor to the International Competition Network.
We look forward to Alden’s posts here at TOTM, the first of which will follow shortly.
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.
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.
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.
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.
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.
- 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.
- 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.
- 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.
In yesterday’s hearings on the disastrous launch of the federal health insurance exchanges, contractors insisted that part of the problem was a last-minute specification from the government: the feds didn’t want people to be able to “window shop” for health insurance until they had created a profile and entered all sorts of personal information.
That’s understandable. For this massive social experiment to succeed — or, at least, to fail less badly — young, healthy people need to buy health insurance. Policy prices for those folks, though, are going to be really high because (1) the ACA requires all sorts of costly coverages people used to be able to decline, and (2) the Act’s “community rating” and “guaranteed issue” provisions prevent insurers from charging older and sicker people an actuarily appropriate rate and therefore require their subsidization by the young and healthy. To prevent the sort of sticker shock that might cause young invincibles to forego purchasing insurance, Obamacare advocates didn’t want them seeing unsubsidized insurance rates. Determining a person’s subsidy, though, requires submisison of all sorts of personal information. Thus, the original requirement that website visitors create a profile and provide gobs of information before seeing insurance rates.
Given the website’s glitches and the difficulty of actually creating a working profile, the feds have now reversed course and are permitting window shopping. An applicant can enter his or her state and county, family size, and age range (<50 or >50) and receive a selection of premium estimates. To avoid dissuading people from applying for coverage in light of high premiums, the website takes great pains to emphasize that the estimated premiums do not account for the available subsidies to which most people will be entitled. For example, to get my own quote, I had to answer a handful of questions and click “Next” a few times, and in the process of doing so, the website announced seven times that the estimated prices I was about to see would not include the generous subsdies to which I would probably be entitled. The Obamacare folks, you see, want us consumers to know what we’re really going to have to pay.
Or do they?
According to the website, I could buy a Coventry Bronze $15 co-pay plan for $218.03 per month (unsubsidized). An Anthem Blue Cross Blue Shield Direct Access Plan would cost me $213.39 per month (unsubsidized). When I went to a private exchange and conducted the same inquiry, however, I learned that the price for the former policy would be $278.66 and, for the latter, between $270.17. So the private exchange tells me the price for my insurance would be 27% percent higher than the amount Healthcare.gov estimates in its window shopping feature. What gives?
As it turns out, the federal exchange assumes (without admitting it) that anyone under age 49 is 27 years old. The private website, by contrast, based quotes on my real age (42). Obviously, the older a person is, the higher the premium will be. Since the ACA mandates that individuals up to age 26 be allowed to stay on their parents’ insurance policies, the age the federal website assumes is the very youngest age at which most people would be required to buy health insurance or pay a penalty. In other words, the federal website picks the rosiest assumption in estimating insurance premiums and never once tells users it’s doing so. It does, however, awkwardly remind them seven times in fewer than seven consecutive screens that their actual premiums will probably be lower than the figure quoted.
Can you imagine if a private firm pulled this sort of stunt? Elizabeth Warren’s friends at the CFPB would be on it like white on rice!
Look, the website problems are a red herring. Sure, they’re shockingly severe, and they do illustrate the limits of government to run things effectively, limits the ACA architects resolutely disregarded. But they’ll get fixed eventually. The main reason they’re a long-term problem is that they exacerbate the Act’s most fundamental flaw: its tendency to create a death spiral of adverse selection in which older and sicker people, beneficiaries under the ACA, purchase health insurance, while young, healthy folks, losers under the Act, forego it. Once this happens, insurance premiums will skyrocket, encouraging even more young and healthy people to drop out of the pool of insureds and thereby making things even worse. The most significant problem stemming from the website “glitches” (my, how that term has been stretched!) is that they have made it so hard to apply for insurance that only those most desperate for it — the old and sick, the ones we least need in the pool of insureds — will go through the rigmarole of signing up. On this point, see Holman Jenkins and George Will.
But who knows. Maybe Zeke Emanuel can fix the problem by getting the Red Sox to sell Obamacare to young invincibles. (I’m not kidding. That was his plan for avoiding adverse selection.)