Archives For antitrust

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

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

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

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

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

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

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

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

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

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

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

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

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

China’s Anti-Monopoly Law (AML) was enacted in 2007, and a stock-taking exercise is now appropriate.  Recently, the Chinese University of Political Science and Law released a questionnaire soliciting public comments on the possible revision of the AML.  On December 10, 2015, George Mason University Law School’s (GMULS) Global Antitrust Institute (GAI, ably managed by FTC Office of International Affairs alumna Koren Wong-Ervin, with academic input from GMULS Professors Douglas Ginsburg, Joshua Wright, and Bruce Kobayashi), submitted a very thoughtful response to the solicitation, recommending that China reform the AML by:

  • Deleting References to Use of Non-Competition Factors in Competition Analysis.  The GAI recommended that references to non-competition goals such as “promoting the healthy development of the socialist market economy,” be deleted, explaining that competition law and policy is most effective when it focuses exclusively upon competition and consumer welfare rather than attempting to achieve simultaneously multiple goals, some of which may be in conflict with others.
  • Deleting Exemptions for State-Owned Enterprises (SOEs). The GAI recommended that SOEs be fully subject to the AML, including liability and fines, explaining that conferring upon SOEs privileges and immunities that are not available to their privately-owned competitors, or based on superior performance or efficiency, distorts competition in the market between state-owned and privately-owned rivals, and that SOEs generate increased agency problems relative to privately owned firms.
  • Recognizing that Vertical Restraints are Generally Procompetitive or Benign and As Such Should Be Analyzed Under an Effects-Based Approach. The GAI recommended that, given the state of economic learning regarding the competitive effects of vertical restraints (i.e., that they rarely harm competition and often benefit consumers by reducing price, increasing demand, and/or creating a more efficient distribution channel), reliance on theoretical models alone to infer competitive harm should generally be insufficient to satisfy the heavy burden on the plaintiff to prove that a particular restraint is anticompetitive.
  • Deleting the Prohibition on Charging “Unfairly High” or Purchasing at “Unfairly Low” Prices. The GAI recommended that this prohibition be deleted in its entirety or, at the very least, revised to explicitly provide an exception for matters involving intellectual property rights.  Among other things, the GAI explained that price regulation risks punishing vigorous competition, and that government-imposed prices that are too high or too low encourage misallocation of resources, soften incentives to engage in efficient conduct, reduce incentives to innovate, and distort markets.  In addition, excessive pricing cases are considered to be among the most difficult and complex cases for competition authorities in terms of standards for assessment, analysis of data, and the design and implementation of suitable remedies.  These difficulties create a substantial risk of both Type I (false positives) and Type II (false negatives) errors.
  • Limiting the Prohibition on Refusals to Deal to Conduct that Creates or Maintains a Monopoly. The GAI explained that, without such a limitation, the prohibition could be interpreted to impose an antitrust-based duty to deal on firms, to micromanage the terms of trade between firms, and to require courts and agencies to administer a burdensome remedy with substantial risk of causing more harm to competition and to consumers than benefits.
  • Deleting the Presumptions Concerning Collective Dominance. The GAI explained that such a presumption may harm rather than promote competition and discourages more rigorous effects-based economic analyses in favor of relying upon easier to apply but less accurate forms of analysis.
  • Clarifying the Definition of Concentration of Undertakings and Exempting Transactions From the Mandatory Premerger Approval Process That Do Not Have a Material Nexus with China. Among other things, the GAI recommended clarification of the terms “control over other undertakings and the ability capable of exerting a decisive influence . . . by virtue of contract or any other means.”
  • Deleting Provisions That Limit AML Enforcement Against Administrative Agencies or Organizations. The GAI recommended the deletion of the provision that grants “superior government agencies,” as opposed to the AML agencies, the authority to remedy anticompetitive conduct by administrative agencies and seemed to except administrative agencies from fines or other AML remedies.  Among other things, the GAI noted the robust economic evidence that regulation often benefits producers and harms consumers and results in efficiency losses from rent-seeking efforts by market participants to influence regulation.
  • Limiting the Requirement that Disgorgement or a Minimum Fine Be Imposed Upon a Finding of an AML Violation and Limiting Fines to Sales Directly Obtained in the Relevant Product and Geographic Market in China Affected By the Violation.
  • Limiting Disgorgement to Naked Price-Fixing Agreements Among Competitors or, In the Case of Unilateral Conduct, to Conduct that Has No Plausible Efficiency Justification.
  • Specifying that the Legitimate Use of Intellectual Property Rights Includes the Right to Exclude.

Today the International Center for Law & Economics (ICLE) submitted an amicus brief to the Supreme Court of the United States supporting Apple’s petition for certiorari in its e-books antitrust case. ICLE’s brief was signed by sixteen distinguished scholars of law, economics and public policy, including an Economics Nobel Laureate, a former FTC Commissioner, ten PhD economists and ten professors of law (see the complete list, below).

Background

Earlier this year a divided panel of the Second Circuit ruled that Apple “orchestrated a conspiracy among [five major book] publishers to raise ebook prices… in violation of § 1 of the Sherman Act.” Significantly, the court ruled that Apple’s conduct constituted a per se unlawful horizontal price-fixing conspiracy, meaning that the procompetitive benefits of Apple’s entry into the e-books market was irrelevant to the liability determination.

Apple filed a petition for certiorari with the Supreme Court seeking review of the ruling on the question of

Whether vertical conduct by a disruptive market entrant, aimed at securing suppliers for a new retail platform, should be condemned as per se illegal under Section 1 of the Sherman Act, rather than analyzed under the rule of reason, because such vertical activity also had the alleged effect of facilitating horizontal collusion among the suppliers.

Summary of Amicus Brief

The Second Circuit’s ruling is in direct conflict with the Supreme Court’s 2007 Leegin decision, and creates a circuit split with the Third Circuit based on that court’s Toledo Mack ruling. ICLE’s brief urges the Court to review the case in order to resolve the significant uncertainty created by the Second Circuit’s ruling, particularly for the multi-sided platform companies that epitomize the “New Economy.”

As ICLE’s brief discusses, the Second Circuit committed several important errors in its ruling:

First, As the Supreme Court held in Leegin, condemnation under the per se rule is appropriate “only for conduct that would always or almost always tend to restrict competition” and “only after courts have had considerable experience with the type of restraint at issue.” Neither is true in this case. Businesses often employ one or more forms of vertical restraints to make entry viable, and the Court has blessed such conduct, categorically holding in Leegin that “[v]ertical price restraints are to be judged according to the rule of reason.”

Furthermore, the conduct at issue in this case — the use of “Most-Favored Nation Clauses” in Apple’s contracts with the publishers and its adoption of the so-called “agency model” for e-book pricing — have never been reviewed by the courts in a setting like this one, let alone found to “always or almost always tend to restrict competition.” There is no support in the case law or economic literature for the proposition that agency models or MFNs used to facilitate entry by new competitors in platform markets like this one are anticompetitive.

Second, the negative consequences of the court’s ruling will be particularly acute for modern, high-technology sectors of the economy, where entrepreneurs planning to deploy new business models will now face exactly the sort of artificial deterrents that the Court condemned in Trinko: “Mistaken inferences and the resulting false condemnations are especially costly, because they chill the very conduct the antitrust laws are designed to protect.” Absent review by the Supreme Court to correct the Second Circuit’s error, the result will be less-vigorous competition and a reduction in consumer welfare.

This case involves vertical conduct essentially indistinguishable from conduct that the Supreme Court has held to be subject to the rule of reason. But under the Second Circuit’s approach, the adoption of these sorts of efficient vertical restraints could be challenged as a per se unlawful effort to “facilitate” horizontal price fixing, significantly deterring their use. The lower court thus ignored the Supreme Court’s admonishment not to apply the antitrust laws in a way that makes the use of a particular business model “more attractive based on the per se rule” rather than on “real market conditions.”

Third, the court based its decision that per se review was appropriate largely on the fact that e-book prices increased following Apple’s entry into the market. But, contrary to the court’s suggestion, it has long been settled that such price increases do not make conduct per se unlawful. In fact, the Supreme Court has held that the per se rule is inappropriate where, as here, “prices can be increased in the course of promoting procompetitive effects.”  

Competition occurs on many dimensions other than just price; higher prices alone don’t necessarily suggest decreased competition or anticompetitive effects. Instead, higher prices may accompany welfare-enhancing competition on the merits, resulting in greater investment in product quality, reputation, innovation or distribution mechanisms.

The Second Circuit presumed that Amazon’s e-book prices before Apple’s entry were competitive, and thus that the price increases were anticompetitive. But there is no support in the record for that presumption, and it is not compelled by economic reasoning. In fact, it is at least as likely that the change in Amazon’s prices reflected the fact that Amazon’s business model pre-entry resulted in artificially low prices, and that the price increases following Apple’s entry were the product of a more competitive market.

Previous commentary on the case

For my previous writing and commentary on the the case, see:

  • “The Second Circuit’s Apple e-books decision: Debating the merits and the meaning,” American Bar Association debate with Fiona Scott-Morton, DOJ Chief Economist during the Apple trial, and Mark Ryan, the DOJ’s lead litigator in the case, recording here
  • Why I think the Apple e-books antitrust decision will (or at least should) be overturned, Truth on the Market, here
  • Why I think the government will have a tough time winning the Apple e-books antitrust case, Truth on the Market, here
  • The procompetitive story that could undermine the DOJ’s e-books antitrust case against Apple, Truth on the Market, here
  • How Apple can defeat the DOJ’s e-book antitrust suit, Forbes, here
  • The US e-books case against Apple: The procompetitive story, special issue of Concurrences on “E-books and the Boundaries of Antitrust,” here
  • Amazon vs. Macmillan: It’s all about control, Truth on the Market, here

Other TOTM authors have also weighed in. See, e.g.:

  • The Second Circuit Misapplies the Per Se Rule in U.S. v. Apple, Alden Abbott, here
  • The Apple E-Book Kerfuffle Meets Alfred Marshall’s Principles of Economics, Josh Wright, here
  • Apple and Amazon E-Book Most Favored Nation Clauses, Josh Wright, here

Amicus Signatories

  • Babette E. Boliek, Associate Professor of Law, Pepperdine University School of Law
  • Henry N. Butler, Dean and Professor of Law, George Mason University School of Law
  • Justin (Gus) Hurwitz, Assistant Professor of Law, Nebraska College of Law
  • Stan Liebowitz, Ashbel Smith Professor of Economics, School of Management, University of Texas-Dallas
  • Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Scott E. Masten, Professor of Business Economics & Public Policy, Stephen M. Ross School of Business, The University of Michigan
  • Alan J. Meese, Ball Professor of Law, William & Mary Law School
  • Thomas D. Morgan, Professor Emeritus, George Washington University Law School
  • David S. Olson, Associate Professor of Law, Boston College Law School
  • Joanna Shepherd, Professor of Law, Emory University School of Law
  • Vernon L. Smith, George L. Argyros Endowed Chair in Finance and Economics,  The George L. Argyros School of Business and Economics and Professor of Economics and Law, Dale E. Fowler School of Law, Chapman University
  • Michael E. Sykuta, Associate Professor, Division of Applied Social Sciences, University of Missouri-Columbia
  • Alex Tabarrok, Bartley J. Madden Chair in Economics at the Mercatus Center and Professor of Economics, George Mason University
  • David J. Teece, Thomas W. Tusher Professor in Global Business and Director, Center for Global Strategy and Governance, Haas School of Business, University of California Berkeley
  • Alexander Volokh, Associate Professor of Law, Emory University School of Law
  • Joshua D. Wright, Professor of Law, George Mason University School of Law

In Collins Inkjet Corp. v. Eastman Kodak Co. (2015) (subsequently settled, leading to a withdrawal of Kodak’s petition for certiorari), the Sixth Circuit elected to apply the Cascade Health Solutions v. PeaceHealth “bundled discount attribution price-cost” methodology in upholding a preliminary injunction against Kodak’s policy of discounting the price of refurbished Kodak printheads to customers who purchased ink from Kodak, rather than from Collins.  This case illustrates the incoherence and economic irrationality of current tying doctrine, and the need for Supreme Court guidance – hopefully sooner rather than later.

The key factual and legal findings in this case, set forth by the Sixth Circuit, were as follows:

Collins is Kodak’s competitor for selling ink for Versamark printers manufactured by Kodak. Users of Versamark printers must periodically replace a printer component called a printhead; Kodak is the only provider of replacement “refurbished printheads” for such printers. In July 2013, Kodak adopted a pricing policy that raised the cost of replacing Versamark printheads, but only for customers not purchasing Kodak ink. Collins filed suit, arguing that this amounts to a tying arrangement prohibited under § 1 of the Sherman Act, 15 U.S.C. § 1, because it is designed to monopolize the Versamark ink market. Collins sought a preliminary injunction barring Kodak from charging Collins’ customers a higher price for refurbished printheads. The district court issued the preliminary injunction, finding a strong likelihood that Kodak’s pricing policy was a non-explicit tie that coerced Versamark owners into buying Kodak ink and that Kodak possessed sufficient market power in the market for refurbished printheads to make the tie effective.

On appeal, Kodak challenges both the legal standard the district court applied to find whether customers were coerced into using Kodak ink and the district court’s preliminary factual findings. In evaluating the likelihood of success on the merits, the district court applied a standard that unduly favored Collins to determine whether customers were coerced into buying Kodak ink. The court examined whether the policy made it likely that all or almost all customers would switch to Kodak ink, but did not examine whether this would be the result of unreasonable conduct on Kodak’s part. A tying arrangement enforced entirely through differential pricing of the tying product contravenes the Sherman Act only if the pricing policy is economically equivalent to selling the tied product below cost. The record makes it difficult to determine conclusively Kodak’s ink production costs, but the available evidence suggests that Kodak was worse off when customers bought both products, meaning that it was in effect selling ink at a loss. Thus, Collins was likely to succeed on the merits even under the correct standard.  Furthermore, the district court was correct in its consideration of the other factors for a preliminary injunction. Accordingly, the preliminary injunction was not an abuse of discretion.

The Sixth Circuit’s Collins Inkjet opinion nicely illustrates the current unsatisfactory state of tying law from an economic perspective.  Unlike in various other areas of antitrust law, such as vertical restraints, exclusionary conduct, and enforcement, the Supreme Court has failed to apply a law and economics standard to tying.  It came close on two occasions, with four Justices supporting a rule of reason standard for tying in Jefferson Parish, and with a Supreme Court majority acknowledging that “[m]any tying arrangements . . . are fully consistent with a free, competitive market” in Independent Ink (which held that it should not be presumed that a patented tying product conveyed market power).  Nevertheless, despite the broad scholarly recognition that tying may generate major economic efficiencies (even when the tying product conveys substantial market power), tying still remains subject to a peculiar rule of limited per se illegality, which is triggered when:  (1) two separate products or services are involved; (2) the sale or agreement to sell one is conditioned on the purchase of the other; (3) the seller has sufficient economic power in the market for the tying product to enable it to restrain trade in the market for the tied product; and (4) a “not insubstantial amount” of interstate commerce in the tied product is affected.  Unfortunately, it is quite possible for plaintiffs to shoehorn much welfare-enhancing conduct into this multipart test, creating a welfare-inimical disincentive for efficiency-seeking businesses to engage in such conduct.  (The U.S. Court of Appeals for the D.C. Circuit refused to apply the per se rule to platform software in United States v. Microsoft, but other appellate courts have not been similarly inclined to flout Supreme Court precedent.)

Courts that are concerned with the efficient application of antitrust may nonetheless evade the confines of the per se rule in appropriate instances, by applying economic reasoning to the factual context presented and finding particular test conditions not met.  The Sixth Circuit’s Collins Inkjet opinion, unfortunately, failed to do so.  It is seriously problematic, in at least four respects.

First, the Sixth Circuit’s opinion agreed with the district court that “coercive” behavior created an “implicit tie,” despite the absence of formal contractual provisions that explicitly tied Kodak’s ink to sale of its refurbished printheads.

Second, it ignored potential vigorous and beneficial ex ante competition among competing producers of printers to acquire customers, which would have negated a finding of significant economic power in the printer market and thereby precluded per se condemnation.

Third, it incorrectly applied the PeaceHealth standard to the facts at hand due to faulty economic reasoning.  For a finding of anticompetitive (“exclusionary”) bundled discounting, PeaceHealth requires that, after all discounts are applied to the “competitive” product, “the resulting price of the competitive product or products is below the defendant’s incremental cost to produce them”.  In Collins Inkjet, all that was known was that Kodak “stood to make more money if customers bought ink from Collins and paid Kodak’s unmatched printhead refurbishment price than if they bought Kodak ink and paid the matched printhead refurbishment price.”  Absent additional information, however, this merely supported a finding that Kodak’s tied ink was priced below its average total cost, not below its (far lower) incremental cost.  (Applying PeaceHealth, the Collins Inkjet court attributed the printhead discount entirely to Kodak’s ink, the tied product.)  In short, absent this error in reasoning (ironically, the court justified its flawed cost analysis “as a matter of formal logic”), the Sixth Circuit could not have based a finding of anticompetitive conduct on the PeaceHealth precedent.

Fourth, and more generally, the Sixth Circuit’s opinion, in its blinkered search for a “modern” (PeaceHealth) finely-calibrated test to apply in this instance, lost sight of the Supreme Court’s broad teaching in Reiter v. Sonotone Corp. that antitrust law was designed to be “a consumer welfare prescription.”  Kodak’s pricing policy that offered discounts to buyers of its printheads and ink yielded lower prices to consumers.  There was no showing that Collins Inkjet would likely be driven out of business, or, even if it were, that consumers would eventually be harmed.  Absent any showing of likely anticompetitive effects, vertical contractual provisions, including tying, should not be subject to antitrust challenge.  Indeed, as Professor (and former Federal Trade Commissioner) Joshua Wright and I have pointed out:

[T]he potential efficiencies associated with . . . tying . . . and the fact that [tying is] prevalent in markets without significant antitrust market power, lead most commentators to believe that [it is] . . . generally procompetitive and should be analyzed under some form of rule of reason analysis. . . .  [T]he adoption of a rule of reason for tying and presumptions of legality for [tying] . . . under certain circumstances may be long overdue.  

In sum, it is high time for the Supreme Court to take an appropriate case and clarify that tying arrangements (whether explicit or “coerced”) are subject to the rule of reason, with full recognition of tying’s efficiencies.  Such a holding would enable businesses to engage in a wider variety of efficient contracts, thereby promoting consumer welfare.

Finally, while it is at it, the Court should also consider taking a loyalty discount case, to reduce harmful uncertainty in this important area (caused by such economically irrational precedents as LePage’s, Inc. v. 3M) and establish a clear standard to guide the business community.  If it takes a loyalty discount case, the Court could beneficially draw upon Wright’s observation that “economic theory and evidence suggest[s] that instances of anticompetitive loyalty discounts will be relatively rare,” and his recommendation that “an exclusive dealing framework . . . be applied in such cases.”

Thanks to the Truth on the Market bloggers for having me. I’m a long-time fan of the blog, and excited to be contributing.

The Third Circuit will soon review the appeal of generic drug manufacturer, Mylan Pharmaceuticals, in the latest case involving “product hopping” in the pharmaceutical industry — Mylan Pharmaceuticals v. Warner Chilcott.

Product hopping occurs when brand pharmaceutical companies shift their marketing efforts from an older version of a drug to a new, substitute drug in order to stave off competition from cheaper generics. This business strategy is the predictable business response to the incentives created by the arduous FDA approval process, patent law, and state automatic substitution laws. It costs brand companies an average of $2.6 billion to bring a new drug to market, but only 20 percent of marketed brand drugs ever earn enough to recoup these costs. Moreover, once their patent exclusivity period is over, brand companies face the likely loss of 80-90 percent of their sales to generic versions of the drug under state substitution laws that allow or require pharmacists to automatically substitute a generic-equivalent drug when a patient presents a prescription for a brand drug. Because generics are automatically substituted for brand prescriptions, generic companies typically spend very little on advertising, instead choosing to free ride on the marketing efforts of brand companies. Rather than hand over a large chunk of their sales to generic competitors, brand companies often decide to shift their marketing efforts from an existing drug to a new drug with no generic substitutes.

Generic company Mylan is appealing U.S. District Judge Paul S. Diamond’s April decision to grant defendant and brand company Warner Chilcott’s summary judgment motion. Mylan and other generic manufacturers contend that Defendants engaged in a strategy to impede generic competition for branded Doryx (an acne medication) by executing several product redesigns and ceasing promotion of prior formulations. Although the plaintiffs generally changed their products to keep up with the brand-drug redesigns, they contend that these redesigns were intended to circumvent automatic substitution laws, at least for the periods of time before the generic companies could introduce a substitute to new brand drug formulations. The plaintiffs argue that product redesigns that prevent generic manufacturers from benefitting from automatic substitution laws violate Section 2 of the Sherman Act.

Product redesign is not per se anticompetitive. Retiring an older branded version of a drug does not block generics from competing; they are still able to launch and market their own products. Product redesign only makes competition tougher because generics can no longer free ride on automatic substitution laws; instead they must either engage in their own marketing efforts or redesign their product to match the brand drug’s changes. Moreover, product redesign does not affect a primary source of generics’ customers—beneficiaries that are channeled to cheaper generic drugs by drug plans and pharmacy benefit managers.

The Supreme Court has repeatedly concluded that “the antitrust laws…were enacted for the protection of competition not competitors” and that even monopolists have no duty to help a competitor. The district court in Mylan generally agreed with this reasoning, concluding that the brand company Defendants did not exclude Mylan and other generics from competition: “Throughout this period, doctors remained free to prescribe generic Doryx; pharmacists remained free to substitute generics when medically appropriate; and patients remained free to ask their doctors and pharmacists for generic versions of the drug.” Instead, the court argued that Mylan was a “victim of its own business strategy”—a strategy that relied on free-riding off brand companies’ marketing efforts rather than spending any of their own money on marketing. The court reasoned that automatic substitution laws provide a regulatory “bonus” and denying Mylan the opportunity to take advantage of that bonus is not anticompetitive.

Product redesign should only give rise to anticompetitive claims if combined with some other wrongful conduct, or if the new product is clearly a “sham” innovation. Indeed, Senior Judge Douglas Ginsburg and then-FTC Commissioner Joshua D. Wright recently came out against imposing competition law sanctions on product redesigns that are not sham innovations. If lawmakers are concerned that product redesigns will reduce generic usage and the cost savings they create, they could follow the lead of several states that have broadened automatic substitution laws to allow the substitution of generics that are therapeutically-equivalent but not identical in other ways, such as dosage form or drug strength.

Mylan is now asking the Third Circuit to reexamine the case. If the Third Circuit reverses the lower courts decision, it would imply that brand drug companies have a duty to continue selling superseded drugs in order to allow generic competitors to take advantage of automatic substitution laws. If the Third Circuit upholds the district court’s ruling on summary judgment, it will likely create a circuit split between the Second and Third Circuits. In July 2015, the Second Circuit court upheld an injunction in NY v. Actavis that required a brand company to continue manufacturing and selling an obsolete drug until after generic competitors had an opportunity to launch their generic versions and capture a significant portion of the market through automatic substitution laws. I’ve previously written about the duty created in this case.

Regardless of whether the Third Circuit’s decision causes a split, the Supreme Court should take up the issue of product redesign in pharmaceuticals to provide guidance to brand manufacturers that currently operate in a world of uncertainty and under the constant threat of litigation for decisions they make when introducing new products.

One baleful aspect of U.S. antitrust enforcers’ current (and misguided) focus on the unilateral exercise of patent rights is an attack on the ability of standard essential patent (SEP) holders to obtain a return that incentivizes them to participate in collective standard setting.  (This philosophy is manifested, for example, in a relatively recent U.S. Justice Department “business review letter” that lends support to the devaluation of SEPs.)  Enforcers accept the view that FRAND royalty rates should compensate licensees only for the value of the incremental difference between the first- and second-best technologies in a hypothetical ex ante competition among patent holders to have their patented technologies included in a proposed standard – a methodology that yields relatively low royalty rates (tending toward zero when the first- and second-best technologies are very close substitutes).  Tied to this perspective is enforcers’ concern with higher royalty rates as reflecting unearned “hold-up value” due to the “lock in” effects of a standard (the premium implementers are willing to pay patent holders whose technologies are needed to practice an established standard).  As a result, strategies by which SEP holders unilaterally seek to maximize returns to their SEP-germane intellectual property, such as threatening lawsuits seeking injunctions for patent infringement, are viewed askance.

The ex ante “incremental value” approach, far from being economically optimal, is inherently flawed.  It is at odds with elementary economic logic, which indicates that “ratcheting down” returns to SEPs in line with an “ex ante competition among technologies” model will lower incentives to invest in patented technologies offered up for consideration by SSOs in a standard- setting exercise.  That disincentive effect will in turn diminish the quality of patents that end up as SEPs – thereby reducing the magnitude of the welfare benefits stemming from standards.  In fact, the notion that FRAND principles should be applied in a manner that guarantees minimal returns to patent holders is inherently at odds with the justification for establishing a patent system in the first place.  That is because the patent system is designed to generously reward large-scale dynamic gains that stem from innovation, while the niggardly “incremental value” yardstick is a narrow static welfare measure that ignores incentive effects (much as the “marginal cost pricing” ideal of neoclassical price theory is inconsistent with Austrian and other dynamic perspectives on marketplace interactions).

Recently, lawyer-economist Greg Sidak outlined an approach to SEP FRAND-based pricing that is far more in line with economic reality – one based on golf tournament prizes.  In a paper to be delivered at the November 5 2015 “Patents in Telecoms” Conference at George Washington University, Sidak explains that collective standard-setting through a standard-setting organization (SSO) is analogous to establishing and running a professional golf tournament.  Like golf tournament organizers, SSOs may be expected to award a substantial prize to the winner that reflects a significant spread between the winner and the runner-up, in order to maximize the benefits flowing from their enterprise.  Relevant excerpts from Sidak’s draft paper (with footnotes omitted and hyperlink added) follow:

“If an inventor could receive only a pittance for his investment in developing his technology and in contributing it to a standard, he would cease contributing proprietary technologies to collective standards and instead pursue more profitable outside options.  That reasoning is even more compelling if the inventor is a publicly traded firm, answerable to its shareholders.  Therefore, modeling standard setting as a static Bertrand pricing game [reflected in the incremental value approach] without any differentiation among the competing technologies and without any outside option for the inventors would predict that every inventor loses—that is, no inventor could possibly recoup his investment in innovation and therefore would quickly exit the market.  Standard setting would be a sucker’s game for inventors.  . . .

[J]ust as the organizer of a golf tournament seeks to ensure that all contestants exert maximum effort to win the tournament, so as to ensure a competitive and entertaining tournament, the SSO must give each participant the incentive to offer the SSO its best technologies. . . .

The rivalrous process—the tournament—by which an SSO identifies and then adopts a particular technology for the standard incidentally produces something else of profound value, something which the economists who invoke static Bertrand competition to model a FRAND royalty manage to obscure.  The high level of inventor participation that a standard-setting tournament is able to elicit by virtue of its payoff structure reveals valuable information about both the inventors and the technologies that might make subsequent rounds of innovation far more socially productive (for example, by identifying dead ends that future inventors need not invest time and money in exploring).  In contrast, the alternative portrayal of standard setting as static Bertrand competition among technologies leads . . . to the dismal prediction that standard setting is essentially a lottery.  The alternative technologies are assumed to be unlimited in number and undifferentiated in quality.  All are equally mediocre. If the standard were instead a motion picture and the competing inventions were instead actors, there would be no movie stars—only extras from central casting, all equally suitable to play the leading role.  In short, a model of competition for adoption of a technology into the standard that, in practical effect, randomly selects its winner and therefore does not aggregate and reveal information is a model that ignores what Nobel laureate Friedrich Hayek long ago argued is the quintessential virtue of a market mechanism.

The economic literature finds that a tournament is efficient when the cost of measuring the absolute output of each participant sufficiently exceeds the cost of measuring the relative output of each participant compared with the other participants.  That condition obtains in the context of SEPs and SSOs.  Measuring the actual output or value of each competing technology for a standard is notoriously difficult.  However, it is much easier to ascertain the relative value of each technology.  SEP holders and implementers routinely make these ordinal comparisons in FRAND royalty disputes. Given the similarities between tournaments and collective standard setting, and the fact that it is far easier to measure the relative value of an SEP than its absolute value, it is productive to analyze the standard-setting process as if it were a tournament. . . .

[I]n addition to guaranteeing participation, the prize structure must provide a sufficient incentive to encourage participants to exert a high level of effort.  In a standard setting context, a “high level of effort” means investing significant capital and other resources to develop new technologies that have commercial value.  The economic literature . . . suggests that the level of effort that a participant exerts depends on the spread, or difference, between the prize for winning the tournament and the next-best prize.  Furthermore, . . . ‘as the spread increases, the incentive to devote additional resources to improving one’s probability of winning increases.’  That result implies that the first-place prize must exceed the second-place prize and that, the greater the disparity between those two prizes, the greater the incentive that participants have to invest in developing new and innovative technologies.”

Sidak’s latest insights are in line with the former bipartisan U.S. antitrust consensus (expressed in the 1995 U.S. Justice Department – Federal Trade Commission IP-Antitrust Guidelines) that antitrust enforcers should focus on targeting schemes that reduce competition among patented technologies, and not challenge unilateral efforts by patentees to maximize returns to their legally-protected property right.  U.S. antitrust enforcers (and their foreign counterparts) would be well-advised to readopt that consensus and abandon efforts to limit returns to SEPs – an approach that is inimical to innovation and to welfare-enhancing dynamic competition in technology markets.

On October 7, 2015, the Senate Judiciary Committee held a hearing on the “Standard Merger and Acquisition Reviews Through Equal Rules” (SMARTER) Act of 2015.  As former Antitrust Modernization Commission Chair (and former Acting Assistant Attorney General for Antitrust) Deborah Garza explained in her testimony, “t]he premise of the SMARTER Act is simple:  A merger should not be treated differently depending on which antitrust enforcement agency – DOJ or the FTC – happens to review it.  Regulatory outcomes should not be determined by a flip of the merger agency coin.”

Ms. Garza is clearly correct.  Both the U.S. Justice Department (DOJ) and the U.S. Federal Trade Commission (FTC) enforce the federal antitrust merger review provision, Section 7 of the Clayton Act, and employ a common set of substantive guidelines (last revised in 2010) to evaluate merger proposals.  Neutral “rule of law” principles indicate that private parties should expect to have their proposed mergers subject to the same methods of assessment and an identical standard of judicial review, regardless of which agency reviews a particular transaction.  (The two agencies decide by mutual agreement which agency will review any given merger proposal.)

Unfortunately, however, that is not the case today.  The FTC’s independent ability to challenge mergers administratively, combined with the difference in statutory injunctive standards that apply to FTC and DOJ merger reviews, mean that a particular merger application may face more formidable hurdles if reviewed by the FTC, rather than DOJ.  These two differences commendably would be eliminated by the SMARTER Act, which would subject the FTC to current DOJ standards.  The SMARTER Act would not deal with a third difference – the fact that DOJ merger consent decrees, but not FTC merger consent decrees, must be filed with a federal court for “public interest” review.  This commentary briefly addresses those three issues.  The first and second ones present significant “rule of law” problems, in that they involve differences in statutory language applied to the same conduct.  The third issue, the question of judicial review of settlements, is of a different nature, but nevertheless raises substantial policy concerns.

  1. FTC Administrative Authority

The first rule of law problem stems from the broader statutory authority the FTC possesses to challenge mergers.  In merger cases, while DOJ typically consolidates actions for a preliminary and permanent injunction in district court, the FTC merely seeks a preliminary injunction (which is easier to obtain than a permanent injunction) and “holds in its back pocket” the ability to challenge a merger in an FTC administrative proceeding – a power DOJ does not possess.  In short, the FTC subjects proposed mergers to a different and more onerous method of assessment than DOJ.  In Ms. Garza’s words (footnotes deleted):

“Despite the FTC’s legal ability to seek permanent relief from the district court, it prefers to seek a preliminary injunction only, to preserve the status quo while it proceeds with its administrative litigation.

This approach has great strategic significance. First, the standard for obtaining a preliminary injunction in government merger challenges is lower than the standard for obtaining a permanent injunction. That is, it is easier to get a preliminary injunction.

Second, as a practical matter, the grant of a preliminary injunction is typically sufficient to end the matter. In nearly every case, the parties will abandon their transaction rather than incur the heavy cost and uncertainty of trying to hold the merger together through further proceedings—which is why merging parties typically seek to consolidate proceedings for preliminary and permanent relief under Rule 65(a)(2). Time is of the essence. As one witness testified before the [Antitrust Modernization Commission], “it is a rare seller whose business can withstand the destabilizing effect of a year or more of uncertainty” after the issuance of a preliminary injunction.

Third, even if the court denies the FTC its preliminary injunction and the parties close their merger, the FTC can still continue to pursue an administrative challenge with an eye to undoing or restructuring the transaction. This is the “heads I win, tails you lose” aspect of the situation today. It is very difficult for the parties to get to the point of a full hearing in court given the effect of time on transactions, even with the FTC’s expedited administrative procedures adopted in about 2008. . . . 

[Moreover,] [while] [u]nder its new procedures, parties can move to dismiss an administrative proceeding if the FTC has lost a motion for preliminary injunction and the FTC will consider whether to proceed on a case-by-case basis[,] . . . th[is] [FTC] policy could just as easily change again, unless Congress speaks.”

Typically time is of the essence in proposed mergers, so substantial delays occasioned by extended reviews of those transactions may prevent many transactions from being consummated, even if they eventually would have passed antitrust muster.  Ms. Garza’s testimony, plus testimony by former Assistant Deputy Assistant Attorney General for Antitrust Abbott (Tad) Lipsky, document cases of substantial delay in FTC administrative reviews of merger proposals.  (As Mr. Lipsky explained, “[a]ntitrust practitioners have long perceived that the possibility of continued administrative litigation by the FTC following a court decision constitutes a significant disincentive for parties to invest resources in transaction planning and execution.”)  Congress should weigh these delay-specific costs, as well as the direct costs of any additional burdens occasioned by FTC administrative procedures, in deciding whether to require the FTC (like DOJ) to rely solely on federal court proceedings.

  1. Differences Between FTC and DOJ Injunctive Standards

The second rule of law problem arises from the lighter burden the FTC must satisfy to obtain injunctive relief in federal court.  Under Section 13(b) of the FTC Act, an injunction shall be granted the FTC “[u]pon a proper showing that, weighing the equities and considering the Commission’s likelihood of success, such action would be in the public interest.”  The D.C. Circuit (in FTC v. H.J. Heinz Co. and in FTC v. Whole Foods Market, Inc.) has stated that, to meet this burden, the FTC need merely have raised questions “so serious, substantial, difficult and doubtful as to make them fair ground for further investigation.”  By contrast, as Ms. Garza’s testimony points out, “under Section 15 of the Clayton Act, courts generally apply a traditional equities test requiring DOJ to show a reasonable likelihood of success on the merits—not merely that there is ‘fair ground for further investigation.’”  In a similar vein, Mr. Lipsky’s testimony stated that “[t]he cumulative effect of several recent contested merger decisions has been to allow the FTC to argue that it needn’t show likelihood of success in order to win a preliminary injunction; specifically these decisions suggest that the Commission need only show ‘serious, substantial, difficult and doubtful’ questions regarding the merits.”  Although some commentators have contended that, in reality, the two standards generally will be interpreted in a similar fashion (“whatever theoretical difference might exist between the FTC and DOJ standards has no practical significance”), there is no doubt that the language of the two standards is different – and basic principles of statutory construction indicate that differences in statutory language should be given meaning and not ignored.  Accordingly, merging parties face the real prospect that they might fare worse under federal court review of an FTC challenge to their merger proposal than they would have fared had DOJ challenged the same transaction.  Such an outcome, even if it is rare, would be at odds with neutral application of the rule of law.

  1. The Tunney Act

Finally, helpful as it is, the SMARTER Act does not entirely eliminate the disparate treatment of proposed mergers by DOJ and the FTC.  The Tunney Act, 15 U.S.C. § 16, enacted in 1974, which applies to DOJ but not to the FTC, requires that DOJ submit all proposed consent judgments under the antitrust laws (including Section 7 of the Clayton Act) to a federal district court for 60 days of public comment prior to being entered.

a.  Economic Costs (and Potential Benefits) of the Tunney Act

The Tunney Act potentially interjects uncertainty into the nature of the “deal” struck between merging parties and DOJ in merger cases.  It does this by subjecting proposed DOJ merger settlements (and other DOJ non-merger civil antitrust settlements) to a 60 day public review period, requiring federal judges to determine whether a proposed settlement is “in the public interest” before entering it, and instructing the court to consider the impact of the entry of judgment “upon competition and upon the public generally.”  Leading antitrust practitioners have noted that this uncertainty “could affect shareholders, customers, or even employees. Moreover, the merged company must devote some measure of resources to dealing with the Tunney Act review—resources that instead could be devoted to further integration of the two companies or generation of any planned efficiencies or synergies.”  More specifically:

“[W]hile Tunney Act proceedings are pending, a merged company may have to consider how its post-close actions and integration could be perceived by the court, and may feel the need to compete somewhat less aggressively, lest its more muscular competitive actions be taken by the court, amici, or the public at large to be the actions of a merged company exercising enhanced market power. Such a distortion in conduct probably was not contemplated by the Tunney Act’s drafters, but merger partners will need to be cognizant of how their post-close actions may be perceived during Tunney Act review. . . .  [And, in addition,] while Tunney Act proceedings are pending, a merged company may have to consider how its post-close actions and integration could be perceived by the court, and may feel the need to compete somewhat less aggressively, lest its more muscular competitive actions be taken by the court, amici, or the public at large to be the actions of a merged company exercising enhanced market power.”

Although the Tunney Act has been justified on traditional “public interest” grounds, even its scholarly supporters (a DOJ antitrust attorney), in praising its purported benefits, have acknowledged its potential for abuse:

“Properly interpreted and applied, the Tunney Act serves a number of related, useful functions. The disclosure provisions and judicial approval requirement for decrees can help identify, and more importantly deter, “influence peddling” and other abuses. The notice-and-comment procedures force the DOJ to explain its rationale for the settlement and provide its answers to objections, thus providing transparency. They also provide a mechanism for third-party input, and, thus, a way to identify and correct potentially unnoticed problems in a decree. Finally, the court’s public interest review not only helps ensure that the decree benefits the public, it also allows the court to protect itself against ambiguous provisions and enforcement problems and against an objectionable or pointless employment of judicial power. Improperly applied, the Tunney Act does more harm than good. When a district court takes it upon itself to investigate allegations not contained in a complaint, or attempts to “re-settle” a case to provide what it views as stronger, better relief, or permits lengthy, unfocused proceedings, the Act is turned from a useful check to an unpredictable, costly burden.”

The justifications presented by the author are open to serious question.  Whether “influence peddling” can be detected merely from the filing of proposed decree terms is doubtful – corrupt deals to settle a matter presumably would be done “behind the scenes” in a manner not available to public scrutiny.  The economic expertise and detailed factual knowledge that informs a DOJ merger settlement cannot be fully absorbed by a judge (who may fall prey to his or her personal predilections as to what constitutes good policy) during a brief review period.  “Transparency” that facilitates “third-party input” can too easily be manipulated by rent-seeking competitors who will “trump up” justifications for blocking an efficient merger.  Moreover, third parties who are opposed to mergers in general may also be expected to file objections to efficient arrangements.  In short, the “sunshine” justification for Tunney Act filings is more likely to cloud the evaluation of DOJ policy calls than to provide clarity.

b.  Constitutional Issues Raised by the Tunney Act

In addition to potential economic inefficiencies, the judicial review feature of the Tunney Act raises serious separation of powers issues, as emphasized by the DOJ Office of Legal Counsel (OLC, which advises the Attorney General and the President on questions of constitutional interpretation) in a 1989 opinion regarding qui tam provisions of the False Claims Act:

“There are very serious doubts as to the constitutionality . . . of the Tunney Act:  it intrudes into the Executive power and requires the courts to decide upon the public interest – that is, to exercise a policy discretion normally reserved to the political branches.  Three Justices of the Supreme Court questioned the constitutionality of the Tunney Act in Maryland v. United States, 460 U.S. 1001 (1983) (Rehnquist, J., joined by Burger, C.J., and White, J., dissenting).”

Notably, this DOJ critique of the Tunney Act was written before the 2004 amendments to that statute that specifically empower courts to consider the impact of proposed settlements “upon competition and upon the public generally” – language that significantly trenches upon Executive Branch prerogatives.  Admittedly, the Tunney Act has withstood judicial scrutiny – no court has ruled it unconstitutional.   Moreover, a federal judge can only accept or reject a Tunney Act settlement, not rewrite it, somewhat ameliorating its affront to the separation of powers.  In short, even though it may not be subject to serious constitutional challenge in the courts, the Tunney Act is problematic as a matter of sound constitutional policy.

c.  Congressional Reexamination of the Tunney Act

These economic and constitutional policy concerns suggest that Congress may wish to carefully reexamine the merits of the Tunney Act.  Any such reexamination, however, should be independent of, and not delay expedited consideration of, the SMARTER Act.  The Tunney Act, although of undoubted significance, is only a tangential aspect of the divergent legal standards that apply to FTC and DOJ merger reviews.  It is beyond the scope of current legislative proposals but it merits being taken up at an appropriate time – perhaps in the next Congress.  When Congress turns to the Tunney Act, it may wish to consider four options:  (1) repealing the Act in its entirety; (2) retaining the Act as is; (3) partially repealing it only with respect to merger reviews; or, (4) applying it in full force to the FTC.  A detailed evaluation of those options is beyond the scope of this commentary.

Conclusion

In sum, in order to eliminate inconsistencies between FTC and DOJ standards for reviewing proposed mergers, Congress should give serious consideration to enacting the SMARTER Act, which would both eliminate FTC administrative review of merger proposals and subject the FTC to the same injunctive standard as the DOJ in judicial review of those proposals.  Moreover, if the SMARTER Act is enacted, Congress should also consider going further and amending the Tunney Act to make it apply to FTC as well as to DOJ merger settlements – or, alternatively, to have it not apply at all to any merger settlements (a result which would better respect the constitutional separation of powers and reduce a potential source of economic inefficiency).

On September 30, in O’Bannon v. NCAA, the U.S. Court of Appeals for the 9th Circuit held that the National Collegiate Athletic Association’s (NCAA) rules that prohibited student athletes from being paid for the use of their names, images, and likenesses are subject to the antitrust laws and constitute an unlawful restraint of trade, under the antitrust rule of reason.  This landmark holding represents the first federal appellate condemnation of NCAA limitations on compensating student athletes.  (In two previous Truth on the Market posts I discussed this lawsuit and later explained that I agreed with the federal district court’s decision striking down these NCAA rules.)  The gist of the 9th Circuit’s opinion is summarized by the Court’s staff:

“The [9th Circuit] panel held that it was not precluded from reaching the merits of plaintiffs’ Sherman Act claim because:  (1) the Supreme Court did not hold in NCAA v. Bd. of Regents of the Univ. of Okla., 468 U.S. 85 (1984), that the NCAA’s amateurism rules are valid as a matter of law; (2) the rules are subject to the Sherman Act because they regulate commercial activity; and (3) the plaintiffs established that they suffered injury in fact, and therefore had standing, by showing that, absent the NCAA’s rules, video game makers would likely pay them for the right to use their names, images, and likenesses in college sports video games.

The panel held that even though many of the NCAA’s rules were likely to be procompetitive, they were not exempt from antitrust scrutiny and must be analyzed under the Rule of Reason.  Applying the Rule of Reason, the panel held that the NCAA’s rules had significant anticompetitive effects within the college education market, in that they fixed an aspect of the “price” that recruits pay to attend college.  The record supported the district court’s finding that the rules served the procompetitive purposes of integrating academics with athletics and preserving the popularity of the NCAA’s product by promoting its current understanding of amateurism.  The panel concluded that the district court identified one proper less restrictive alternative to the current NCAA rules – i.e., allowing NCAA members to give scholarships up to the full cost of attendance – but the district court’s other remedy, allowing students to be paid cash compensation of up to $5,000 per year, was erroneous.  The panel vacated the district court’s judgment and permanent injunction insofar as they required the NCAA to allow its member schools to pay student-athletes up to $5,000 per year in deferred compensation.

Chief Judge Thomas concurred in part and dissented in part. He  disagreed with the [two judge panel] majority’s conclusion that the district court clearly erred in ordering the NCAA to permit up to $5,000 in deferred compensation above student-athletes’ full cost of attendance.”

The key point of the 9th Circuit’s decision, that competitively restrictive rules are not exempt from antitrust scrutiny because they promote the perception of “amateurism,” is clearly correct, and in line with modern antitrust jurisprudence.  The Supreme Court has taught that anticompetitive restrictions aimed at furthering the reputation of the learned professions (see Goldfarb v. Virginia State Bar (1975), striking down a minimum legal fee schedule for title searches), and their ability to advance social goals effectively (see FTC v. Superior Court Trial Lawyers Association (1990), condemning a joint effort to raise government-paid legal aid fees and thereby “enhance” the quality of legal aid representation), are fully subject to antitrust review.  Even the alleged desire to ensure that quality medical services are not sacrificed (see FTC v. Indiana Federation of Dentists (1986), rejecting a dental association’s agreement to deny insurers’ request for procedure-specific dental x-rays), and that safety is maintained in major construction projects (see National Society of Professional Engineers v. United States (1978), striking down an ethical canon barring competitive bids for engineering services), do not shield agreements from antitrust evaluation and potential condemnation.  In light of those teachings, the NCAA’s claim (based on a clear misreading of the Supreme Court’s NCAA v. Board of Regents (1984) decision) that its highly restrictive “amateurism” rules should be exempt from antitrust review is patently absurd.

Moreover, as a matter of substance, the NCAA is precisely the sort of institution whose rules merit close evaluation by antitrust enforcers.  The NCAA is a monopsony cartel, representing the institutions (America’s colleges) which effectively are the sole buyers of the services of high school football and basketball players who hope to pursue professional sports careers.  Moreover, the NCAA’s rules regarding student athletes greatly limit competition, artificially limit athletes’ compensation, and are in severe tension with the “scholar-athlete” ideal that the NCAA claims it promotes.  In 2011, the late University of Chicago Professor Gary Becker, a Nobel Laureate in Economics, put it starkly:

“[T]he NCAA sharply limits the number of athletic scholarships, and even more importantly, limits the size of the scholarships that schools can offer the best players.  NCAA rules also severely restricts the gifts and housing players are allowed to receive from alumni and others, do not allow college players to receive pay for playing for professional teams during summers or even before they attended college, and limits what they can be paid for non-playing summer work.  The rules are extremely complicated, and they constitute hundreds of pages that lay out what is permitted in recruiting prospective students, when students have to make binding commitments to attend schools, the need to renew athletic scholarships, the assistance that can be provided to players’ parents, and of course the size of scholarships.

It is impossible for an outsider to look at these rules without concluding that their main aim is to make the NCAA an effective cartel that severely constrains competition among schools for players.  The NCAA defends these rules by claiming that their main purpose is to prevent exploitation of student-athletes, to provide a more equitable system of recruitment that enables many colleges to maintain football and basketball programs and actively search for athletes, and to insure that the athletes become students as well as athletes. Unfortunately for the NCAA, the facts are blatantly inconsistent with these defenses. .

A large fraction of the Division I players in basketball and football, the two big money sports, are recruited from poor families; many of them are African-Americans from inner cities and rural areas. Every restriction on the size of scholarships that can be given to athletes in these sports usually takes money away from poor athletes and their families, and in effect transfers these resources to richer students in the form of lower tuition and cheaper tickets for games. . . .

[T]he graduation rates for these minority students-athletes are depressingly low. For example, the average graduation rate of Division I African American basketball and football players appears to be less than 50%.

Some of the top players quit school to play in the NBA or NFL, but that is a tiny fraction of all athletes who dropout.  The vast majority dropout either because they use up their sports eligibility before they completed the required number of classes, or they failed to continue to make the teams.  Schools usually forget about athletes when they stop competing.  An important further difference between athletes and non-athletes who drop out of school is that athletes would have been able to get much better financial support for themselves and their families but for the NCAA restrictions on compensation to athletes.  They could have used these additional assets to help them finish school, or to get a better start if they dropped out.”

Also in 2011, Judge Richard Posner of the 7th Circuit echoed Professor Becker’s views regarding NCAA student competition rules and noted the NCAA’s history of avoiding antitrust problems:

“The National Collegiate Athletic Association behaves monopsonistically in forbidding its member colleges and universities to pay its athletes.  Although cartels, including monopsonistic ones, are generally deemed to be illegal per se under American antitrust law, the NCAA’s monopsonistic behavior has thus far not been successfully challenged.  The justification that the NCAA offers – that collegiate athletes are students and would be corrupted by being salaried – coupled with the fact that the members of the NCAA, and the NCAA itself, are formally not-for-profit institutions, have had sufficient appeal to enable the association to continue to impose and enforce its rule against paying student athletes, and a number of subsidiary rules designed to prevent the cheating by cartel members that plagues most cartels.

As Becker points out, were it not for the monopsonistic rule against paying student athletes, these athletes would be paid; the monopsony transfers wealth from them to their “employers,” the colleges. A further consequence is that college teams are smaller and, more important, of lower quality than they would be if the student athletes were paid.”

In sum, the 9th Circuit O’Bannon Court merits praise for deciding clearly and unequivocally that antitrust applies to the NCAA’s student athlete rules, irrespective of whether one agrees with the specific holding in the case.  The antitrust laws are a “consumer welfare prescription” that applies generally to activities that have an impact on interstate commerce, and short shrift should be given to the claim by any institution that it should be antitrust-exempt based on the alleged “virtue” or “public-spiritedness” of its actions.  (This reasoning also supports the lifting of baseball’s antitrust exemption, which stems from a 1922 Supreme Court decision that is out of step with modern antitrust jurisprudence.  But that is a matter for another day.)

On September 30, in O’Bannon v. NCAA, the U.S. Court of Appeals for the 9th Circuit held that the National Collegiate Athletic Association’s (NCAA) rules that prohibited student athletes from being paid for the use of their names, images, and likenesses are subject to the antitrust laws and constitute an unlawful restraint of trade, under the antitrust rule of reason. This landmark holding represents the first federal appellate condemnation of NCAA limitations on compensating student athletes. (In two previous Truth on the Market posts I discussed this lawsuit and later explained that I agreed with the federal district court’s decision striking down these NCAA rules.) The gist of the 9th Circuit’s opinion is summarized by the Court’s staff:

The [9th Circuit] panel held that it was not precluded from reaching the merits of plaintiffs’ Sherman Act claim because: (1) the Supreme Court did not hold in NCAA v. Bd. of Regents of the Univ. of Okla., 468 U.S. 85 (1984), that the NCAA’s amateurism rules are valid as a matter of law; (2) the rules are subject to the Sherman Act because they regulate commercial activity; and (3) the plaintiffs established that they suffered injury in fact, and therefore had standing, by showing that, absent the NCAA’s rules, video game makers would likely pay them for the right to use their names, images, and likenesses in college sports video games.

The panel held that even though many of the NCAA’s rules were likely to be procompetitive, they were not exempt from antitrust scrutiny and must be analyzed under the Rule of Reason. Applying the Rule of Reason, the panel held that the NCAA’s rules had significant anticompetitive effects within the college education market, in that they fixed an aspect of the “price” that recruits pay to attend college. The record supported the district court’s finding that the rules served the procompetitive purposes of integrating academics with athletics and preserving the popularity of the NCAA’s product by promoting its current understanding of amateurism. The panel concluded that the district court identified one proper less restrictive alternative to the current NCAA rules – i.e., allowing NCAA members to give scholarships up to the full cost of attendance – but the district court’s other remedy, allowing students to be paid cash compensation of up to $5,000 per year, was erroneous. The panel vacated the district court’s judgment and permanent injunction insofar as they required the NCAA to allow its member schools to pay student-athletes up to $5,000 per year in deferred compensation.

Chief Judge Thomas concurred in part and dissented in part. He disagreed with the [two judge panel] majority’s conclusion that the district court clearly erred in ordering the NCAA to permit up to $5,000 in deferred compensation above student-athletes’ full cost of attendance.

The key point of the 9th Circuit’s decision, that competitively restrictive rules are not exempt from antitrust scrutiny because they promote the perception of “amateurism,” is clearly correct, and in line with modern antitrust jurisprudence. The Supreme Court has taught that anticompetitive restrictions aimed at furthering the reputation of the learned professions (see Goldfarb v. Virginia State Bar (1975), striking down a minimum legal fee schedule for title searches), and their ability to advance social goals effectively (see FTC v. Superior Court Trial Lawyers Association (1990), condemning a joint effort to raise government-paid legal aid fees and thereby “enhance” the quality of legal aid representation), are fully subject to antitrust review. Even the alleged desire to ensure that quality medical services are not sacrificed (see FTC v. Indiana Federation of Dentists (1986), rejecting a dental association’s agreement to deny insurers’ request for procedure-specific dental x-rays), and that safety is maintained in major construction projects (see National Society of Professional Engineers v. United States (1978), striking down an ethical canon barring competitive bids for engineering services), do not shield agreements from antitrust evaluation and potential condemnation. In light of those teachings, the NCAA’s claim (based on a clear misreading of the Supreme Court’s NCAA v. Board of Regents (1984) decision) that its highly restrictive “amateurism” rules should be exempt from antitrust review is patently absurd.

Moreover, as a matter of substance, the NCAA is precisely the sort of institution whose rules merit close evaluation by antitrust enforcers. The NCAA is a monopsony cartel, representing the institutions (America’s colleges) which effectively are the sole buyers of the services of high school football and basketball players who hope to pursue professional sports careers. Moreover, the NCAA’s rules regarding student athletes greatly limit competition, artificially limit athletes’ compensation, and are in severe tension with the “scholar-athlete” ideal that the NCAA claims it promotes. In 2011, the late University of Chicago Professor Gary Becker, a Nobel Laureate in Economics, put it starkly:

[T]he NCAA sharply limits the number of athletic scholarships, and even more importantly, limits the size of the scholarships that schools can offer the best players. NCAA rules also severely restricts the gifts and housing players are allowed to receive from alumni and others, do not allow college players to receive pay for playing for professional teams during summers or even before they attended college, and limits what they can be paid for non-playing summer work. The rules are extremely complicated, and they constitute hundreds of pages that lay out what is permitted in recruiting prospective students, when students have to make binding commitments to attend schools, the need to renew athletic scholarships, the assistance that can be provided to players’ parents, and of course the size of scholarships.

It is impossible for an outsider to look at these rules without concluding that their main aim is to make the NCAA an effective cartel that severely constrains competition among schools for players. The NCAA defends these rules by claiming that their main purpose is to prevent exploitation of student-athletes, to provide a more equitable system of recruitment that enables many colleges to maintain football and basketball programs and actively search for athletes, and to insure that the athletes become students as well as athletes. Unfortunately for the NCAA, the facts are blatantly inconsistent with these defenses. . . .
A large fraction of the Division I players in basketball and football, the two big money sports, are recruited from poor families; many of them are African-Americans from inner cities and rural areas. Every restriction on the size of scholarships that can be given to athletes in these sports usually takes money away from poor athletes and their families, and in effect transfers these resources to richer students in the form of lower tuition and cheaper tickets for games. . . .

[T]he graduation rates for these minority students-athletes are depressingly low. For example, the average graduation rate of Division I African American basketball and football players appears to be less than 50%.

Some of the top players quit school to play in the NBA or NFL, but that is a tiny fraction of all athletes who dropout. The vast majority dropout either because they use up their sports eligibility before they completed the required number of classes, or they failed to continue to make the teams. Schools usually forget about athletes when they stop competing. An important further difference between athletes and non-athletes who drop out of school is that athletes would have been able to get much better financial support for themselves and their families but for the NCAA restrictions on compensation to athletes. They could have used these additional assets to help them finish school, or to get a better start if they dropped out.

Also in 2011, Judge Richard Posner of the 7th Circuit echoed Professor Becker’s views regarding NCAA student competition rules and noted the NCAA’s history of avoiding antitrust problems:

The National Collegiate Athletic Association behaves monopsonistically in forbidding its member colleges and universities to pay its athletes. Although cartels, including monopsonistic ones, are generally deemed to be illegal per se under American antitrust law, the NCAA’s monopsonistic behavior has thus far not been successfully challenged. The justification that the NCAA offers – that collegiate athletes are students and would be corrupted by being salaried – coupled with the fact that the members of the NCAA, and the NCAA itself, are formally not-for-profit institutions, have had sufficient appeal to enable the association to continue to impose and enforce its rule against paying student athletes, and a number of subsidiary rules designed to prevent the cheating by cartel members that plagues most cartels.

As Becker points out, were it not for the monopsonistic rule against paying student athletes, these athletes would be paid; the monopsony transfers wealth from them to their “employers,” the colleges. A further consequence is that college teams are smaller and, more important, of lower quality than they would be if the student athletes were paid.

In sum, the 9th Circuit O’Bannon Court merits praise for deciding clearly and unequivocally that antitrust applies to the NCAA’s student athlete rules, irrespective of whether one agrees with the specific holding in the case. The antitrust laws are a “consumer welfare prescription” that applies generally to activities that have an impact on interstate commerce, and short shrift should be given to any institution that claims it should be antitrust-exempt based on the alleged “virtue” or “public-spiritedness” of its actions. (This reasoning also supports the lifting of baseball’s antitrust exemption, which stems from a 1922 Supreme Court decision that is out of step with modern antitrust jurisprudence. But that is a matter for another day.)