Section 2 Symposium: Bill Kolasky on a Stepwise Rule of Reason for Exclusionary Conduct

William J. Kolasky —  5 May 2009

kolaskyWilliam Kolasky is a partner in WilmerHale’s Regulatory and Government Affairs Department, a member of the firm’s Antitrust and Competition Practice Group, and a former Deputy Assistant Attorney General in the Antitrust Division at the Department of Justice.

The most controversial part of the Justice Department’s Single Firm Conduct Report is the Department’s proposed use of what it terms a “substantial disproportionality” test for exclusionary conduct. Under this test, the Justice Department would bring a case only if the harm to consumers and competition caused by a dominant or near-dominant firm’s conduct is “substantially disproportionate” to any legitimate benefits the firm might realize. The Department argues that this test is superior to the three alternative tests it considers—an effects-balancing test, a no-economic-sense test, and an equally-efficient-competitor test—because it is more administrable and because it reduces the risk of false positives (i.e., finding conduct unlawful that does not harm competition ), which the Department views as more serious than that of false negatives (i.e., finding conduct lawful that does harm competition).

Critics of the Department’s report argue that this test places a finger on the scale in favor of monopolists and near-monopolists, leaving consumers and smaller competitors with too little protection, and it is certainly easy to see why the test gives rise to this perception. But there is another, more fundamental problem with the Justice Department’s proposed test – namely, that it perpetuates the outdated view of the rule of reason as an ad hoc balancing test, and does not take into account the extent to which the Supreme Court and the lower courts have given greater structure to rule of reason analysis over the last thirty years.Part of the problem is that courts do not generally describe the analytical framework they use to apply Section 2 as a “rule of reason” framework in the same manner as they do under section 1. Yet, as the D.C. Circuit recognized in its Microsoft decision, Section 2 analysis proceeds very much in the same stepwise manner as modern rule of reason analysis under section 1. Thus, the plaintiff has the initial burden of showing that the conduct at issue is “anticompetitive” in the sense that it tends “to exclude rivals on some basis other than efficiency” (Aspen) – in other words, that excludes or handicaps rivals without benefiting consumers. If the plaintiff meets this initial burden, then the defendant may try to rebut the plaintiff’ showing by proffering a procompetitive justification for its conduct. If it does so, then the burden shifts back to the plaintiff to rebut that claim by, for example, showing that the claimed justification is pretextual or that it could be achieved through less competitively restrictive alternatives. If the plaintiff cannot rebut the procompetitive justifications in this manner, then the plaintiff must demonstrate that the anticompetitive harm outweighs the procompetitive benefits.

These, of course, are the same steps courts follow in analyzing alleged restraints of trade under modern section 1 rule-of-reason analysis. What the Justice Department report overlooks in proposing its substantial disproportionality test is that the courts almost never reach the last step of this analysis, in which they overtly balance the anticompetitive and procompetitive effects of the alleged conduct. Rather, as Professor Michael Carrier of Rutgers has documented, courts resolve virtually all rule-of-reason cases, under both section 1 and section 2, at one of the first three steps. They do this by applying what the Supreme Court in California Dental Association v. FTC, called a “sliding scale” or, more elegantly, an “enquiry meet for the case.” Thus, they rarely, if ever, actually balance the anticompetitive and procompetitive effects.

At the first step, the courts generally require a plaintiff to show substantial harm to competition in order to meet its initial burden. Harm to a single competitor, or trivial harm to competition, will not do. Then at the second step, the degree of scrutiny to which a court subjects any proffered justifications will depend on how strong the showing of harm to competition is. In cases like NCAA and Indiana Federation, where the harm to competition is obvious and substantial, the court will scrutinize the proffered justifications closely and will look hard for less restrictive alternatives. Conversely, where the showing of harm to competition is weak, the degree of scrutiny of proffered justifications will be much more casual.

The stepwise, sliding-scale framework the courts now use to apply the rule of reason is very similar to the more structured framework the Supreme Court has developed over the last forty years to enforce the constitutional guarantees of free speech and equal protection. In the 1960s, there was a debate over whether the courts should use a balancing test to protect these rights or should instead try to develop neutral principles to enforce them. The Court resolved this debate by converting what had been an ad hoc balancing test into a more structured stepwise inquiry that looks first at the nature of the infringement and then varies the degree of scrutiny to which the court will subject the proffered governmental justifications with the seriousness of the infringement.

Because the Justice Department report fails to acknowledge that the rule of reason has likewise evolved from an ad hoc balancing test to a structured, stepwise, sliding-test test for anticompetitive conduct, its concern that the rule of reason, if applied neutrally, will produce too many false positive seems exaggerated. When one examines Section 2 decisions in the Supreme Court and the courts of appeals over the last quarter century, it is hard to find evidence to support the Department’s fear that false positives are more likely and more serious than false negatives. Plaintiffs have won very few Section 2 cases, and most of those wins are in cases like Conwood and Microsoft, where the evidence of harm to competition was quite strong and the proffered justifications very weak.

The bottom line is that the Department, by neglecting to review the case law under section 2, failed to make a persuasive case for its substantial disproportionality test. It would have been far better for it to have more fully embraced the rule of reason analytical framework enunciated by the D.C. Circuit in Microsoft, but with more emphasis on the need to use a sliding scale in applying that framework, which the Supreme Court endorsed in California Dental.

2 responses to Section 2 Symposium: Bill Kolasky on a Stepwise Rule of Reason for Exclusionary Conduct

  1. 

    Courts “rarely, if ever, actually balance the anticompetitive and procompetitive effects.”

    My post makes a similar point about Microsoft’s burden-shifting approach. In Microsoft itself, as in other cases, the burden never shifted more than once, and the initial characterization of the practice was almost always decisive. I would disagree, however, that, in Microsoft, the “evidence of harm to competition was quite strong.” There was evidence of harm to “nascent” rivals and a story (albeit one that Microsoft itself believed) about how those firms might have evolved into an actual rival in an undefined future market. Whether that sort of showing should shift the burden to the defendant to offer an efficiency justification for competitive conduct, including choices about product design, is unclear.

  2. 

    I’d like to take issue with following statement in your post about the relationship between false positives and the appropriate liability standards. You wrote:

    “When one examines Section 2 decisions in the Supreme Court and the courts of appeals over the last quarter century, it is hard to find evidence to support the Department’s fear that false positives are more likely and more serious than false negatives. Plaintiffs have won very few Section 2 cases, and most of those wins are in cases like Conwood and Microsoft, where the evidence of harm to competition was quite strong and the proffered justifications very weak.”

    First, the argument is frequently raised that those pointing to fear of false positives are exaggerating their case because it is difficult to prove that the probability of false positives exceeds that of false negatives. But the error cost framework is concerned with the probability of those errors weighed by the social harm they are likely to cause.

    Even if one believed that false positives were not likely, it does not follow that they need not be a major concern for the design of antitrust liability rules.

    A second and related point is using plaintiff win rates in Section 2 cases to say something meaningful about the incidence of false positives. A common refrain is: show me a false positive monopolization case! The real social costs of false positives, and the thing that folks who are concerned with false positives are worried about, are not about the single business practice that is condemned by an antitrust judgment. The real costs are the chilling of pro-competitive behavior by other firms in response to the expectation of the same type of judgment against them. To say something sensible about the incidence of these errors and costs, you cannot just count cases because those aren’t where the costs are (not to mention much of the expectation of liability from pro-competitive behavior is to do with the threat of settlements — does anybody really think that N-Data is not having some chilling effect on pro-consumer conduct? LePage’s?).

    Third, you cite Conwood as a case where the “evidence of harm to competition was quite strong and the proffered justifications very weak.” This is wrong. In fact, I’ve written elsewhere that Conwood is a fairly good example of a false positive (forthcoming in SCER, but link available here). And I know there is a significant debate to this day over the competitive effects of Microsoft’s conduct in the literature. But let me focus on Conwood since I’ve written about it.

    It is true most commentators focus on the product destruction and allegations of misleading retailers and discuss Conwood as a classic example of a “cheap exclusion case,” much like the textbook example of blowing up the rival’s factory. But there are some problems with this characterization, not the least of which is that Section 2 still requires that plaintiffs demonstrate actual competitive harm and engage in some analysis on that issue. A close look at the evidence in Conwood suggests that the evidence is woefully insufficient with respect to competitive harm.

    Also, commentators frequently (following the Sixth Circuit’s example) ignore the fact that Conwood prevailed under a Section 2 theory that included not just the tortious conduct, but also presumptively pro-competitive conduct such as offering loyalty programs and category management services to retailers. The Sixth Circuit never disaggregated lawful from unlawful conduct for the purposes of liability or damages analysis. But the more important point for our purposes is that a case involving some allegations of indisputably “bad” conduct (product destruction), but little evidence of consumer harm, resulted in a Section 2 judgment and expensive settlements that swept in pro-competitive conduct like exclusive dealing and category management contracts.

    Regarding the characterization of the evidence in that case as “quite strong,” I’m not alone in my belief that it is incorrect. Consider that the damages calculations at trial have been heavily criticized by many antitrust and evidence scholars. See, e.g. D.H. Kaye’s analyses in the Virgina Law Review and Jurimetrics (2003), a scathing amicus brief in support of a writ for certiorari from several leading economists attacking the damages estimates, and a lengthy critical discussion in Herbert Hovenkamp’s Antitrust Enterprise which makes Conwood the poster child of sorts of the case against private litigation.

    Fourth, if we don’t use plaintiff win rates what do we do? Well, we should look at the existing empirical evidence that provides information on the incidence of anticompetitive business behavior as well as the social costs of both types of errors. Both are useful in designing liability rules that do not harm consumers by over or under-deterring efficient conduct. But while the available data is not overwhelmingly abundant, we can learn some lessons from it. One is that the literature documenting exclusionary distribution contracts with convincing statistical evidence just isn’t there other than a few examples here and there. And its not that nobody is looking. Economists don’t get tenure nowadays for demonstrating that something is efficient. On the other hand, the bulk of the literature on vertical restraints and single firm conduct suggests that the conduct is pro-consumer most of the time. Another informative point for the error cost approach that suggests that perhaps those concerned with false positives are responding rationally to the evidence.

    Finally, and I know this is getting long, I’d like to tie this back to the debate over the appropriate general standard (if we’re to have one). I’m generally in favor of conduct-specific standards, so don’t have very strong priors about the relative merits of the stepwise approach versus the substantial disproportionality approach. But the point is that the relative merits of those standards, or potential candidates for conduct-specific standards, ought to turn on evidence of the incidence of anticompetitive conduct and the magnitude of social costs associated with both types of errors. To improve antitrust rules, it is true we need desperately to expand our body of knowledge on these scores. However, we’ve got an existing body of knowledge that is quite helpful for many forms of single firm conduct and my view is the debate over the relative merits of competing candidate rules ought to turn on that evidence rather than plaintiff win rates.