The FTC Abandons the Free Market

Jonathan M. Barnett —  2 May 2022

[The ideas in this post from Truth on the Market regular Jonathan M. Barnett of USC Gould School of Law—the eighth entry in our FTC UMC Rulemaking symposiumare developed in greater detail in “Regulatory Rents: An Agency-Cost Analysis of the FTC Rulemaking Initiative,” a chapter in the forthcoming book FTC’s Rulemaking Authority, which will be published by Concurrences later this year. This is the first of two posts we are publishing today; see also this related post from Aaron Nielsen of BYU Law. You can find other posts at the symposium page here. Truth on the Market also invites academics, practitioners, and other antitrust/regulation commentators to send us 1,500-4,000 word responses for potential inclusion in the symposium.]

In December 2021, the Federal Trade Commission (FTC) released its statement of regulatory priorities for 2022, which describes its intention to expand the agency’s rulemaking activities to target “unfair methods of competition” (UMC) under Section 5 of the Federal Trade Commission Act (FTC Act), in addition to (and in some cases, presumably in place of) the conventional mechanism of case-by-case adjudication. Agency leadership (meaning, the FTC chair and the majority commissioners) largely characterizes the rulemaking initiative as a logistical improvement to enable the agency to more efficiently execute its statutory commitment to preserve competitive markets. Unburdened by the costs and delays inherent to the adjudicative process (which, in the antitrust context, typically requires evidence of actual or likely competitive harm), the agency will be able to take expedited action against UMCs based on rules preemptively set forth by the agency. 

This shift from enforcement by adjudication to enforcement by rulemaking is far from a mechanical adjustment. Rather, it is best understood as part of an initiative to make fundamental changes to the substance and methodology of antitrust enforcement.  Substantively, the initiative appears to be part of a broader effort to alter the goals of antitrust enforcement so that it promotes what are deemed to be “equitable” market outcomes, rather than preserving the competitive process through which outcomes are determined by market forces. Methodologically, the initiative appears to be part of a broader effort to displace rule-of-reason treatment with the practical equivalent of per se prohibitions in a wide range of putatively “unfair” practices. Both steps would be inconsistent with the agency’s statutory mission to safeguard the competitive process or a meaningful commitment to a market-driven economy and the rule of law.

Abandoning Competitive Markets

Little steps sometimes portend bigger changes. 

In July 2021, FTC leadership removed the following words from the mission description of the agency’s Bureau of Competition: “The Bureau’s work aims to preserve the free market system and assure the unfettered operation of the forces of supply and demand.” This omitted statement had tracked what remains the standard characterization by federal courts and agency guidelines of the core objective of the antitrust laws. Following this characterization, the antitrust laws seek to preserve the “rules of the game” for market competition, while remaining indifferent to the outcomes of such competition in any particular market. It is the competitive process, not the fortunes of particular competitors, that matters.

Other statements by FTC leadership suggest that they seek to abandon this outcome-agnostic perspective. A memo from the FTC chair to staff, distributed in September 2021, states that the agency’s actions “shape the distribution of power and opportunity” and encourages staff “to take a holistic approach to identifying harms, recognizing that antitrust and consumer protection violations harm workers and independent businesses as well as consumers.” In a draft strategic plan distributed by FTC leadership in October 2021, the agency described its mission as promoting “fair competition” for the “benefit of the public.”  In contrast, the agency’s previously released strategic plan had described the agency’s mission as promoting “competition” for the benefit of consumers, consistent with the case law’s commitment to protecting consumer welfare, dating at least to the Supreme Court’s 1979 decision in Reiter v. Sonotone Corp. et al. The change in language suggests that the agency’s objectives encompass a broad range of stakeholders and policies (including distributive objectives) that extends beyond, and could conflict with, its commitment to preserve the integrity of the competitive process.

These little steps are part of a broader package of “big steps” undertaken during 2021 by FTC leadership. 

In July 2021, the agency abandoned decades of federal case law and agency guidelines by rejecting the consumer-welfare standard for purposes of enforcement of Section 5 of the FTC Act against UMCs. Relatedly, FTC leadership asserted in the same statement that Congress had delegated to the agency authority under Section 5 “to determine which practices fell into the category of ‘unfair methods of competition’”. Remarkably, the agency’s claimed ambit of prosecutorial discretion to identify “unfair” practices is apparently only limited by a commitment to exercise such power “responsibly.”

This largely unbounded redefinition of the scope of Section 5 divorces the FTC’s enforcement authority from the concepts and methods as embodied in decades of federal case law and agency guidelines interpreting the Sherman and Clayton Acts. Those concepts and methods are in turn anchored in the consumer-welfare principle, which ensures that regulatory and judicial actions promote the public interest in the competitive process, rather than the private interests of any particular competitor or other policy goals not contemplated by the antitrust laws. Effectively, agency leadership has unilaterally converted Section 5 into an empty vessel into which enforcers may insert a fluid range of business practices that are deemed by fiat to pose a risk to “fair” competition. 

Abandoning the Rule of Reason

In the same statement in which FTC leadership rejected the consumer-welfare principle for purposes of Section 5 enforcement, it rejected the relevance of the rule of reason for these same purposes. In that statement, agency leadership castigated the rule of reason as a standard that “leads to soaring enforcement costs” and asserted that it is incompatible with Section 5 of the FTC Act. In March 2021 remarks delivered to the House Judiciary Committee’s Antitrust Subcommittee, Commissioner Rebecca Kelly Slaughter similarly lamented “[t]he effect of cramped case law,” specifically viewing as problematic the fact that “[u]nder current Section 5 jurisprudence, courts have to consider conduct under the ‘rule of reason,’ a fact-intensive investigation into whether the anticompetitive effects of the conduct outweigh the procompetitive justifications.” Hence, it appears that the FTC, in exercising its purported rulemaking powers against UMCs under Section 5, does not intend to undertake the balancing of competitive harms and gains that is the signature element of rule-of-reason analysis. Tellingly, the agency’s draft strategic plan, released in October 2021, omits language that it would execute its enforcement mission “without unduly burdening legitimate business activity” (language that had appeared in the previously released strategic plan)—again, suggesting that it plans to take littleaccount of the offsetting competitive gains attributable to a particular business practice.

This change in methodology has two profound and concerning implications. 

First, it means that any “unfair” practice targeted by the agency under Section 5 is effectively subject to a per se prohibition—that is, the agency can prevail merely by identifying that the defendant engaged in a particular practice, rather than having to show competitive harm. Note that this would represent a significant step beyond the per se rule that Sherman Act case law applies to certain cases of horizontal collusion. In those cases, a per se rule has been adopted because economic analysis indicates that these types of practices in general pose such a high risk of net anticompetitive harm that a rule-of-reason inquiry is likely to fail a cost-benefit test almost all of the time. By contrast, there is no indication that FTC leadership plans to confine its rulemaking activities to practices that systematically pose an especially high risk of anticompetitive harm, in part because it is not clear that agency leadership still views harm to the competitive process as being the determinative criterion in antitrust analysis.  

Second, without further clarification from agency leadership, this means that the agency appears to place substantially reduced weight on the possibility of “false positive” error costs. This would be a dramatic departure from the conventional approach to error costs as reflected in federal antitrust case law. Antitrust scholars have long argued, and many courts have adopted the view, that “false positive” costs should be weighted more heavily relative to “false negative” error costs, principally on the ground that, as Judge Richard Posner once put it, “a cartel . . . carries within it the seeds of its own destruction.” To be clear, this weighted approach should still meaningfully assess the false-negative error costs that arise from mistaken failures to intervene. By contrast, the agency’s blanket rejection of the rule of reason in all circumstances for Section 5 purposes raises doubt as to whether it would assign any material weight to false-positive error costs in exercising its purported rulemaking power under Section 5 against UMCs. Consistent with this possibility, the agency’s July 2021 statement—which rejected the rule of reason specifically—adopted the view that Section 5 enforcement should target business practices in their “incipiency,” even absent evidence of a “likely” anticompetitive effect.

While there may be reasonable arguments in favor of an equal weighting of false-positive and false-negative error costs (on the grounds that markets are sometimes slow to correct anticompetitive conduct, as compared to the speed with which courts correct false-positive interventions), it is hard to fathom a reasonable policy argument in favor of placing no material weight on the former cost category. Under conditions of uncertainty, the net economic effect of any particular enforcement action, or failure to take such action, gives rise to a mix of probability-adjusted false-positive and false-negative error costs. Hence, any sound policy framework seeks to minimize the sum of those costs. Moreover, the wholesale rejection of a balancing analysis overlooks extensive scholarship identifying cases in which federal courts, especially during the period prior to the Supreme Court’s landmark 1977 decision in Continental TV Inc. v. GTE Sylvania Inc., applied per se rules that erroneously targeted business practices that were almost certainly generating net-positive competitive gains. Any such mistaken intervention counterproductively penalizes the efforts and ingenuity of the most efficient firms, which then harms consumers, who are compelled to suffer higher prices, lower quality, or fewer innovations than would otherwise have been the case.

The dismissal of efficiency considerations and false-positive error costs is difficult to reconcile with an economically informed approach that seeks to take enforcement actions only where there is a high likelihood of improving economic welfare based on available evidence. On this point, it is worth quoting Oliver Williamson’s well-known critique of 1960s-era antitrust: “[I]f neither the courts nor the enforcement agencies are sensitive to these [efficiency] considerations, the system fails to meet a basic test of economic rationality. And without this the whole enforcement system lacks defensible standards and becomes suspect.”

Abandoning the Rule of Law

In a liberal democratic system of government, the market relies on the state’s commitment to set forth governing laws with adequate notice and specificity, and then to enforce those laws in a manner that is reasonably amenable to judicial challenge in case of prosecutorial error or malfeasance. Without that commitment, investors are exposed to arbitrary enforcement and would be reluctant to place capital at stake. In light of the agency’s concurrent rejection of the consumer-welfare and rule-of-reason principles, any future attempt by the FTC to exercise its purported Section 5 rulemaking powers against UMCs under what currently appears to be a regime of largely unbounded regulatory discretion is likely to violate these elementary conditions for a rule-of-law jurisdiction. 

Having dismissed decades of learning and precedent embodied in federal case law and agency guidelines, FTC leadership has declined to adopt any substitute guidelines to govern its actions under Section 5 and, instead, has stated (in its July 2021 statement rejecting the consumer-welfare principle) that there are few bounds on its authority to specify and target practices that it deems to be “unfair.” This blunt approach contrasts sharply with the measured approach reflected in existing agency guidelines and federal case law, which seek to delineate reasonably objective standards to govern enforcers’ and courts’ decision making when evaluating the competitive merits of a particular business practice.  

This approach can be observed, even if imperfectly, in the application of the Herfindahl-Hirschman Index (HHI) metric in the merger-review process and the use of “safety zones” (defined principally by reference to market-share thresholds) in the agencies’ Antitrust Guidelines for the Licensing of Intellectual Property, Horizontal Merger Guidelines, and Antitrust Guidelines for Collaborations Among Competitors. This nuanced and evidence-based approach can also be observed in a decision such as California Dental Association v. FTC (1999), which provides a framework for calibrating the intensity of a rule-of-reason inquiry based on a preliminary assessment of the likely net competitive effect of a particular practice. In making these efforts to develop reasonably objective thresholds for triggering closer scrutiny, regulators and courts have sought to reconcile the open-ended language of the offenses described in the antitrust statutes—“restraint of trade” (Sherman Act Section 1) or “monopolization” (Sherman Act Section 2)—with a meaningful commitment to providing the market with adequate notice of the inherently fuzzy boundary between competitive and anti-competitive practices in most cases (and especially, in cases involving single-firm conduct that is most likely to be targeted by the agency under its Section 5 authority). 

It does not appear that agency leadership intends to adopt this calibrated approach in implementing its rulemaking initiative, in light of its largely unbounded understanding of its Section 5 enforcement authority and wholesale rejection of the rule-of-reason methodology. If Section 5 is understood to encompass a broad and fluid set of social goals, including distributive objectives that can conflict with a commitment to the competitive process, then there is no analytical reference point by which markets can reliably assess the likelihood of antitrust liability and plan transactions accordingly. If enforcement under Section 5, including exercise of any purported rulemaking powers, does not require the agency to consider offsetting efficiencies attributable to any particular practice, then a chilling effect on everyday business activity and, more broadly, economic growth can easily ensue. In particular, firms may abstain from practices that may have mostly or even entirely procompetitive effects simply because there is some material likelihood that any such practice will be subject to investigation and enforcement under the agency’s understanding of its Section 5 authority and its adoption of a per se approach for which even strong evidence of predominantly procompetitive effects would be moot.

From Free Markets to Administered Markets

The FTC’s proposed rulemaking initiative, when placed within the context of other fundamental changes in substance and methodology adopted by agency leadership, is not easily reconciled with a market-driven economy in which resources are principally directed by the competitive forces of supply and demand. FTC leadership has reserved for the agency discretion to deem a business practice as “unfair,” while defining fairness by reference to an agglomeration of loosely described policy goals that include—but go beyond, and in some cases may conflict with—the agency’s commitment to preserve market competition. Concurrently, FTC leadership has rejected the rule-of-reason balancing approach and, by implication, may place no material weight on (or even fail to consider entirely) the efficiencies attributable to a particular business practice. 

In the aggregate, any rulemaking activity undertaken within this unstructured framework would make it challenging for firms and investors to assess whether any particular action is likely to trigger agency scrutiny. Faced with this predicament, firms could only substantially reduce exposure to antitrust liability by seeking various forms of preclearance with FTC staff, who would in turn be led to issue supplemental guidance, rules, and regulations to handle the high volume of firm inquiries. Contrary to the advertised advantages of enforcement by rulemaking, this unavoidable cycle of rule interpretation and adjustment would likely increase substantially aggregate transaction and compliance costs as compared to enforcement by adjudication. While enforcement by adjudication occurs only periodically and impacts a limited number of firms, enforcement by rulemaking is a continuous activity that impacts all firms. The ultimate result: the free play of the forces of supply and demand would be replaced by a continuously regulated environment where market outcomes are constantly being reviewed through the administrative process, rather than being worked out through the competitive process.  

This is a state of affairs substantially removed from the “free market system” to which the FTC’s Bureau of Competition had once been committed. Of course, that may be exactly what current agency leadership has in mind.

Jonathan M. Barnett

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Jonathan M. Barnett is the Torrey H. Webb Professor of Law at the University of Southern California’s Gould School of Law.

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