The FTC has filed its primary appellate brief in the Whole Foods case. In essence, the brief asserts two claims: that the district court evaluated the Commission’s request for a preliminary injunction under an overly stringent legal standard, and that the court improperly discounted the Commission’s evidence that a Whole Foods/Wild Oats merger would reduce competition and harm consumers. While the Commission is wrong on both points, this appeal might be a good thing — it could provide the courts (maybe even the Supreme Court!) with an opportunity to do some much-needed house cleaning on merger policy.
Under the FTC Act, the Commission may seek a preliminary injunction whenever it has reason to believe “(1) that any person, partnership, or corporation is violating, or is about to violate, any provision of law enforced by the Federal Trade Commission, and (2) that the enjoining thereof pending … [judicial resolution of a formal complaint] would be in the interest of the public.” (Because the FTC enforces the Clayton Act’s ban on mergers that “may substantially lessen competition,” the Commission may seek to preliminarily enjoin such mergers.) The statute goes on to say that the petitioned court may grant the preliminary injunction “[u]pon a proper showing that, weighing the equities and considering the Commission’s likelihood of ultimate success, such action would be in the public interest….”
The FTC contends, quite correctly, that this standard is more liberal than the traditional equitable standard for awarding a preliminary injunction. But the district court recognized as much. Cutting quotation marks, citations, and parentheticals, here’s how the court construed the FTC’s proof burden (pp. 5-6):
In contrast to the four-part equity standard for the granting of a preliminary injunction in other contexts, in deciding whether to grant preliminary injunctive relief under section 13(b), the court evaluates whether it is in the public interest to enjoin the proposed merger. This standard is broader than the traditional equity standard that is normally applicable to requests for injunctive relief and is consistent with Congress’ intention that injunctive relief be broadly available to the FTC. The FTC is not required to establish that the proposed merger would in fact violate section 7 of the Clayton Act. It is required only to show that it is â€œlikelyâ€¯ to succeed in showing under Section 7 of the Clayton Act that the proposed merger â€œmay substantially lessen competitionâ€¯ or â€œtend to create a monopoly.â€¯ The FTC must show a â€œreasonable probabilityâ€¯ that the proposed merger may substantially lessen competition in the future. The FTC’s burden is not insubstantial, and a showing of fair or tenable chance of success on the merits will not suffice for injunctive relief. To meet its burden to establish its likelihood of success on the merits, the FTC may raise questions going to the merits so serious, substantial, difficult and doubtful as to make them fair ground for thorough investigation, study, deliberation and determination by the FTC in the first instance and ultimately by the Court of Appeals. The FTC does not have to prove that the proposed merger will in fact violate Section 7 of the Clayton Act because the Congress used the words may be substantially to lessen competition to indicate that its concern was with probabilities, not certainties.
That’s a pretty darn deferential standard. The Commission is required to show only that it is “likely” to be able to show that the proposed merger “may” substantially reduce competition.
So suppose a merger proposal presents four equally plausible scenarios — one in which competition is substantially reduced, two in which competition is enhanced (say, because of enhanced economies of scale), and one in which thereâ€™s no noticeable change in competition. Suppose, though, that itâ€™s hard to tell the productive efficiencies story — either the theory is hard to follow or the data establishing the likely efficiency gains are hard to produce. In light of this difficulty, thereâ€™s a 50% chance that the ultimate factfinder will altogether discount the two enhanced competition scenarios. That means thereâ€™s a 50% chance the factfinder will conclude that there are two equally plausible outcomes: one in which competition is substantially reduced, and one in which thereâ€™s no noticeable effect on competition. Under these facts, the FTC should win; it has shown that it is â€œlikelyâ€¯ to succeed in showing that the proposed merger â€œmayâ€¯ substantially reduce competition. Thus, the merger would be barred even though the actual likelihood of anticompetitive effect is only 25%. The district court’s proof standard endorses this FTC-friendly outcome.
So what’s the Commission’s beef with the district court’s proof standard? I suppose the Commission is upset over the statement that “[t]he FTC’s burden is not insubstantial, and a showing of fair or tenable chance of success on the merits will not suffice for injunctive relief.” But surely the Court of Appeals shouldn’t endorse a standard that permits the FTC to prevail as long as it discharges an “insubstantial” burden and demonstrates only that it has a “fair or tenable” chance of showing that competition may be reduced. In the merger context, “preliminary” injunctions are final in fact (the merging parties walk away from the deal if a PI is granted), and most mergers offer at least some good news for consumers in the form of enhanced productive efficiencies (from economies of scale, etc.). Thus, we shouldn’t make it too easy for the FTC to squelch a merger.
Moroever, lowering the PI proof standard from that which the district court employed would create further divergence between the rules applicable to the FTC and those applicable to the other agency charged with pre-merger review, the Department of Justice. Because of some statutory quirks, mergers challenged by the DOJ cannot be effectively thwarted on so slight a showing. The bipartisan Antitrust Modernization Commission recently observed that differences between the two agenciesâ€™ pre-merger reviews â€œcan undermine the publicâ€™s confidence that the antitrust agencies are reviewing mergers efficiently and fairly.â€¯ The AMC recommended (Rec. #26, pp. 141-42) that the standard for granting injunctive relief to the FTC be raised to mirror that applicable to DOJ requests. Any ruling that lowered the FTC’s proof standard below that utilized by the trial court in the Whole Foods case would effect precisely the opposite result.
So how about the FTC’s claim that the district court misevaluated the evidence of likely anticompetitive effect? Wrong again. One of the FTC’s primary assertions here is that the court failed to give credit to various internal documents suggesting that the merger would have an anticompetitive effect. The main such “hot document” was an email Whole Foods CEO John Mackey sent to the board of directors, arguing that the merger would “avoid nasty price wars” in certain markets and would deny conventional grocers the “springboard” they’d need to get into Whole Foods’ market space. Other internal documents suggested, the FTC maintains, that Whole Foods considered itself so unique that it did not compete in the same market as conventional grocery stores. The district court’s 90+ page opinion did not discuss most of this evidence, leading the FTC to charge that the court committed reversible error in discounting “the gold standard of probative evidence” on the merger’s competitive effects.
In fact, it was entirely appropriate for the district court to discount internal hot docs in favor of the cold hard economic data, which showed that there is substantial competitive interaction between Whole Foods and conventional grocery stores and that Wild Oats does not provide a unique constraint on Whole Foods’ pricing. (As the district court explained, the data showed that “Whole Foods prices are essentially the same at all the stores in its region, regardless of whether there is a Wild Oats store nearby.”)
The FTC’s claim that internal documents are “the gold standard of probative evidence” on market definition or a merger’s likely effects is just wrong. Business people routinely make puffing claims about the uniqueness of the product or service they are selling, and it would be naÃ¯ve to infer from such self-serving claims that the products or services at issue really are so unique that the seller could raise prices above competitive levels without causing buyers to substitute toward alternatives. Whole Foodsâ€™ claim to be a â€œlifestyle retailerâ€¯ offering â€œa unique shopping environmentâ€¯ says next to nothing about whether shoppers would really refrain from substituting to, say, a Safeway Lifestyle Market in response to a price increase. Similarly, aggressive â€œfighting wordsâ€¯ in internal communications generally say little about the real purpose of planned conduct â€” much less the likely effect of such conduct. For example, the inflammatory â€œavoid nasty price warsâ€¯ language quoted at the beginning of the FTCâ€™s complaint appeared in a last-minute e-mail that was designed to drum up board support for the Wild Oats merger. One could not infer the true purpose of the merger from this out-of-context snippet and, even if one could, it is effect â€” not purpose â€” that really matters. Divining likely effect requires a hard look at economic data rather than consideration of statements lifted out of context.
My esteemed co-blogger, Geoff (along with Marc Williamson) has persuasively criticized the use of â€œhot docs vs. cold economicsâ€¯ in antitrust enforcement. Manne and Williamson observe that accounting documents, market definition documents, and documents containing â€œfighting wordsâ€¯ frequently give rise to economically inaccurate inferences. They explain:
Business people will often characterize information from a business perspective, and these characterizations may seem to have economic implications. However, business actors are subject to numerous forces that influence the rhetoric they use and the conclusions they draw. These factors include salesmanship; self-promotion; the need to take credit for successes and deny responsibility for failures; the need to develop consensus; and the desire to win support for an initiative or to neutralize its opponents. . . . Simply put, the words and procedures used by business people do not necessarily reflect â€œeconomic realities,â€¯ and the effort to integrate them further into antitrust analysis is misdirected.
Thus, it was entirely appropriate for the district court to focus on hard economic data — the real gold standard of probative evidence — rather than inflammatory hot docs.
To be sure, the FTC also goes after the district court’s analysis of the economic data. It argues, for example, that the court ignored evidence that “the presence of Wild Oats in a market reduced Whole Foods’ profit margins by .7 percent, storewide.” Come again? This is the sort of evidence that’s supposed to justify the court’s thwarting of a merger in an industry in which scale economies are substantial (so that a larger merged firm can exploit otherwise unavailable productive efficiencies)? First, the relevant consideration is effect on prices, not profit margins; an increase in profit margins can occur when per-unit costs decrease, and one might well expect a “busy” Whole Foods in a non-Wild Oats area to have greater efficiencies (less wasted perishables, etc.) than a less active Whole Foods in an area with a Wild Oats. In addition, the market power-induced price increases leading to a 0.7 percent increase in profit margins are probably really small. In a merger of Whole Foods and Wild Oats, the enhanced market power resulting in these tiny price increases would be accompanied by productive efficiencies (scale economies, etc.) that would likely dwarf the market power-induced price hikes. The net effect (a small increase in market power with a more sizeable increase in productive efficiency) would almost certainly benefit consumers.
And speaking of productive efficiencies, they are never mentioned in the FTC’s appeal or in Prof. Murphy’s expert report. Indeed, Prof. Murphy begins his expert report with the list of questions the FTC asked him to consider (p. 7, par. 21), and nowhere on that list is any consideration of offsetting productive efficiencies — an almost certain result of the merger at issue and a matter the FTC, pursuant to its own merger guidelines, is supposed to consider. In light of this glaring oversight, should the courts be more deferential to the Commission, as it now contends?
It seems, then, that the FTC is wrong all around. Still, I’m glad it’s pursuing this appeal. Merger appeals are rare. When regulators lose a merger challenge, they generally don’t appeal because mergers usually close shortly after the district court rules, and most consummated mergers are quite difficult to undo. When the parties to a merger agreement lose, they usually give up because they know they probably can’t hold the merger agreement together for the duration of an appeal. The result has been a dearth of Supreme Court merger decisions; the last significant one was United States v. General Dynamics Corp., decided in 1974.
There is a good chance the current Supreme Court would agree to hear an appeal of this case if it were to proceed that far. Unlike the Rehnquist Court it succeeded, the Roberts Court has shown significant interest in antitrust matters. Indeed, in the last two terms, the Court decided seven antitrust cases, compared to an average of less than one per year in the 15 years prior to the 2003â€“2004 term. An appeal of the Whole Foods case would present the Court with the opportunity to do some much-needed house-cleaning on merger analysis. Most notably, the Court could correct some of the unfortunate vestiges of its Brown Shoe decision, which stated that “submarkets” could be defined, in part, according to such â€œpractical indiciaâ€¯ as â€œindustry or public recognition of the market as a separate economic entity, the productâ€™s peculiar characteristics and uses, unique production facilities, distinct customers, distinct prices, sensitivity to price changes, and specialized vendors.â€¯ This unfortunate statement invited litigants and regulators to scour business documents for market characterizations that suit their end. Unfortunately, those characterizations are frequently inaccurate, and, as this case well shows, reliance on business documents rather than econometric evidence often leads to mistakes.
My esteemed co-blogger, Josh, has recently opined that the Roberts Court will hear an appeal of a merger challenge (p. 55 of this article). Whole Foods just could be the case.