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Balto on the Apple e-books case: Skip the (Apple) appetizer and get to the (McWane) main course

David Balto —  15 February 2016

The “magic” of Washington can only go so far. Whether it is political consultants trying to create controversy where there is basic consensus, such as in parts of the political campaign, or the earnest effort to create a controversy over the Apple decision, there may be lots of words exchanged and animated discussion by political and antitrust pundits, but at the end of the day it’s much ado about not much. For the Apple case, even though this blog has attracted some of the keenest creative antitrust thinkers, a simple truth remains – there was overwhelming evidence that there was a horizontal agreement among suppliers and that Apple participated or even led the agreement as a seller. This is, by definition, a hub-and-spoke conspiracy that resulted in horizontal price fixing among ebook suppliers – an activity worthy of per se treatment.

The simplicity of this case belies the controversy of the ruling and the calls for Supreme Court review. Those that support Apple’s petition for certiorari seem to think that the case is a good vehicle to address important questions of policy in the law. Indeed, ICLE submitted an excellent brief making just such a case. But, unfortunately, the facts of this case are not great for resolving these problems.

For example, some would like to look at this case not as a horizontal price fixing agreement among competitors facilitated by a vertical party, but instead as a series of vertical agreements. This is very tempting, because the antitrust revolution was built on the back of fixing harmful precedent of per se condemnation of vertical restraints. Starting with GTE Sylvania, the Supreme Court has repeatedly applied modern economic learning to vertical restraints and found that there are numerous potential procompetitive benefits that must be accounted for in any proper antitrust analysis of a vertical agreement.

This view of the Apple e-book case is especially tempting because the Supreme Court’s work in this area of the law is not done. For example, the Supreme Court needs to update the law on exclusive dealing and loyalty discounts to reflect post-GTE Sylvania thinking, something I have written extensively on (including here at TOTM: here, here and here) in the context of the McWane case. (Which is also up for cert review). However, the facts of this case simply make this a bad case to resolve any matter of vertical restraint law. Apple was not approaching publishers individually, but aggressively orchestrating a scheme that immediately raised e-book prices by 30% and ensured that Apple’s store could not be undercut by any competitor. Consumers were very obviously harmed and the horizontal price fixing conspiracy could not have taken place without Apple’s involvement.

Of course in the court of public opinion (which is not an antitrust court) Apple attempted to wear the garb of the Robin Hood for consumers suggesting it was just trying to respond to Amazon’s dominance over ebooks. But the Justice Department and the court quickly saw through that guise. The proper response to market dominance is to compete harder. And that’s what happened. Apple’s successful entry into the e-book market seems to provide a more effective response than any cartel. But this does not show that there were procompetitive benefits of Apple’s anticompetitive actions worthy of rule of reason treatment. To the contrary, prices rose and output fell during the conduct at issue – exactly what one would expect to see following anticompetitive activities.

This argument also presupposes that Amazon’s dominance was bad for consumers. This is refuted by Scalia in Trinko:

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices–at least for a short period–is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.

The other problem with this line of thinking is that it suggests that it is OK to violate the antitrust laws to prevent a rival from charging too low of a price. This would obviously be bad policy. If Amazon was maintaining its dominant position through anticompetitive conduct, then there exists recourse in the law. As the old adage states, two wrongs do not make a right.

The main problem with the Apple e-book case is that it is a very simple case that lightly brushes against up against areas of law that and questions of policy that are attractive for Supreme Court review. There are important policy issues that still need to be addressed by the Supreme Court, but these facts don’t present them.

The Supreme Court does have an important job in helping antitrust law evolve in a sensible fashion. But this case is a soggy appetizer when there is a much more engaging main course about to be served. A cert petition has been filed in the FTC’s case against McWane, which provides a chance to update the law of exclusive dealing which the Court has not grappled with since the days of Sputnik (Only a slight exaggeration). And in McWane the most important business groups Including the Chamber of Commerce and the National Association of Manufacturers have explained that the confusion and obscurity in this area and the mischief of the lower court’s decisions create real impediments to procompetitive conduct. Professors of law and economics (including several TOTM authors) also wrote in support of the petition.

The Court should skip the appetizer and get to the main course.

In Amazon, Antitrust & Competition, Apple, Exclusive Dealing, Monopolization, Platforms, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , , , , ,
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Spicy Documents Serve up a Paltry Antitrust Meal

David Balto —  13 November 2014

There is always a temptation for antitrust agencies and plaintiffs to center a case around so-called “hot” documents — typically company documents with a snippet or sound-bites extracted, some times out of context. Some practitioners argue that “[h]ot document can be crucial to the outcome of any antitrust matter.” Although “hot” documents can help catch the interest of the public, a busy judge or an unsophisticated jury, they often can lead to misleading results. But more times than not, antitrust cases are resolved on economics and what John Adams called “hard facts,” not snippets from emails or other corporate documents. Antitrust case books are littered with cases that initially looked promising based on some supposed hot documents, but ultimately failed because the foundations of a sound antitrust case were missing.

As discussed below this is especially true for a recent case brought by the FTC, FTC v. St. Luke’s, currently pending before the Ninth Circuit Court of Appeals, in which the FTC at each pleading stage has consistently relied on “hot” documents to make its case.

The crafting and prosecution of civil antitrust cases by federal regulators is a delicate balancing act. Regulators must adhere to well-defined principles of antitrust enforcement, and on the other hand appeal to the interests of a busy judge. The simple way of doing this is using snippets of documents to attempt to show the defendants knew they were violating the law.

After all, if federal regulators merely had to properly define geographic and relevant product markets, show a coherent model of anticompetitive harm, and demonstrate that any anticipated harm would outweigh any procompetitive benefits, where is the fun in that? The reality is that antitrust cases typically rely on economic analysis, not snippets of hot documents. Antitrust regulators routinely include internal company documents in their cases to supplement the dry mechanical nature of antitrust analysis. However, in isolation, these documents can create competitive concerns when they simply do not exist.

With this in mind, it is vital that antitrust regulators do not build an entire case around what seem to be inflammatory documents. Quotes from executives, internal memoranda about competitors, and customer presentations are the icing on the cake after a proper antitrust analysis. As the International Center for Law and Economics’ Geoff Manne once explained,

[t]he problem is that these documents are easily misunderstood, and thus, while the economic significance of such documents is often quite limited, their persuasive value is quite substantial.

Herein lies the problem illustrated by the Federal Trade Commission’s use of provocative documents in its suit against the vertical acquisition of Saltzer Medical Group, an independent physician group comprised of 41 doctors, by St. Luke’s Health System. The FTC seeks to stop the acquisition involving these two Idaho based health care providers, a $16 million transaction, and a number comparatively small to other health care mergers investigated by the antitrust agencies. The transaction would give St. Luke’s a total of 24 primary care physicians operating in and around Nampa, Idaho.

In St. Luke’s the FTC used “hot” documents in each stage of its pleadings, from its complaint through its merits brief on appeal. Some of the statements pulled from executives’ emails, notes and memoranda seem inflammatory suggesting St. Luke’s intended to increase prices and to control market share all in order to further its strength relative to payer contracting. These statements however have little grounding in the reality of health care competition.

The reliance by the FTC on these so-called hot documents is problematic for several reasons. First, the selective quoting of internal documents paints the intention of the merger solely to increase profit for St. Luke’s at the expense of payers, when the reality is that the merger is premised on the integration of health care services and the move from the traditional fee-for-service model to a patient-centric model. St Luke’s intention of incorporating primary care into its system is in-line with the goals of the Affordable Care Act to promote over all well-being through integration. The District Court in this case recognized that the purpose of the merger was “primarily to improve patient outcomes.” And, in fact, underserved and uninsured patients are already benefitting from the transaction.

Second, the selective quoting suggested a narrow geographic market, and therefore an artificially high level of concentration in Nampa, Idaho. The suggestion contradicts reality, that nearly one-third of Nampa residents seek primary care physician services outside of Nampa. The geographic market advanced by the FTC is not a proper market, regardless of whether selected documents appear to support it. Without a properly defined geographic market, it is impossible to determine market share and therefore prove a violation of the Clayton Antitrust Act.

The DOJ Antitrust Division and the FTC have acknowledged that markets can not properly be defined solely on spicy documents. Writing in their 2006 commentary on the Horizontal Merger Guidelines, the agencies noted that

[t]he Agencies are careful, however, not to assume that a ‘market’ identified for business purposes is the same as a relevant market defined in the context of a merger analysis. … It is unremarkable that ‘markets’ in common business usage do not always coincide with ‘markets’ in an antitrust context, inasmuch as the terms are used for different purposes.

Third, even if St. Luke’s had the intention of increasing prices, just because one wants to do something such as raise prices above a competitive level or scale back research and development expenses — even if it genuinely believes it is able — does not mean that it can. Merger analysis is not a question of mens rea (or subjective intent). Rather, the analysis must show that such behavior will be likely as a result of diminished competition. Regulators must not look at evidence of this subjective intent and then conclude that the behavior must be possible and that a merger is therefore likely to substantially lessen competition. This would be the tail wagging the dog. Instead, regulators must first determine whether, as a matter of economic principle, a merger is likely to have a particular effect. Then, once the analytical tests have been run, documents can support these theories. But without sound support for the underlying theories, documents (however condemning) cannot bring the case across the goal line.

Certainly, documents suggesting intent to raise prices should bring an antitrust plaintiff across the goal line? Not so, as Seventh Circuit Judge Frank Easterbrook has explained:

Almost all evidence bearing on “intent” tends to show both greed and desire to succeed and glee at a rival’s predicament. … [B]ut drive to succeed lies at the core of a rivalrous economy. Firms need not like their competitors; they need not cheer them on to success; a desire to extinguish one’s rivals is entirely consistent with, often is the motive behind competition.

As Harvard Law Professor Phil Areeda observed, relying on documents describing intent is inherently risky because

(1) the businessperson often uses a colorful and combative vocabulary far removed from the lawyer’s linguistic niceties, and (2) juries and judges may fail to distinguish a lawful competitive intent from a predatory state of mind. (7 Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law § 1506 (2d ed. 2003).)

So-called “hot” documents may help guide merger analysis, but served up as a main course make a paltry meal. Merger cases rise or fall on hard facts and economics, and next week we will see if the Ninth Circuit recognizes this as both St. Luke’s and the FTC argue their cases.

In Antitrust & Competition, Antitrust Division, Federal Trade Commission, Google, Health Care, International Center for Law & Economics, Justice Department, Merger Guidelines, Mergers & Acquisitions, Platforms , , , , , ,
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Antitrust Enforcement in Reverse: Getting Efficiencies Backwards

David Balto —  11 September 2014

A century ago Congress enacted the Clayton Act, which prohibits acquisitions that may substantially lessen competition. For years, the antitrust enforcement Agencies looked at only one part of the ledger – the potential for price increases. Agencies didn’t take into account the potential efficiencies in cost savings, better products, services, and innovation. One of the major reforms of the Clinton Administration was to fully incorporate efficiencies in merger analysis, helping to develop sound enforcement standards for the 21st Century.

But the current approach of the Federal Trade Commission (“FTC”), especially in hospital mergers, appears to be taking a major step backwards by failing to fully consider efficiencies and arguing for legal thresholds inconsistent with sound competition policy. The FTC’s approach used primarily in hospital mergers seems uniquely misguided since there is a tremendous need for smart hospital consolidation to help bend the cost curve and improve healthcare delivery.

The FTC’s backwards analysis of efficiencies is juxtaposed in two recent hospital-physician alliances.

As I discussed in my last post, no one would doubt the need for greater integration between hospitals and physicians – the debate during the enactment of the Affordable Care Act (“ACA”) detailed how the current siloed approach to healthcare is the worst of all worlds, leading to escalating costs and inferior care. In FTC v. St. Luke’s Health System, Ltd., the FTC challenged Boise-based St. Luke’s acquisition of a physician practice in neighboring Nampa, Idaho.

In the case, St. Luke’s presented a compelling case for efficiencies.

As noted by the St. Luke’s court, one of the leading factors in rising healthcare costs is the use of the ineffective fee-for-service system. In their attempt to control costs and abandon fee-for-service payment, the merging parties effectively demonstrated to the court that the combined entity would offer a high level of coordinated and patient-centered care. Therefore, along with integrating electronic records and increasing access for under-privileged patients, the merged entity can also successfully manage population health and offer risk-based payment initiatives to all employed physicians. Indeed, the transaction consummated several months ago has already shown significant cost savings and consumer benefits especially for underserved patients. The court recognized

[t]he Acquisition was intended by St. Luke’s and Saltzer primarily to improve patient outcomes. The Court believes that it would have that effect if left intact.

(Appellants’ Reply Brief at 22, FTC v. St. Luke’s Health Sys., No 14-35173 (9th Cir. Sept. 2, 2014).)

But the court gave no weight to the efficiencies primarily because the FTC set forward the wrong legal roadmap.

Under the FTC’s current roadmap for efficiencies, the FTC may prove antitrust harm via predication and presumption while defendants are required to decisively prove countervailing procompetitive efficiencies. Such asymmetric burdens of proof greatly favor the FTC and eliminate a court’s ability to properly analyze the procompetitive nature of efficiencies against the supposed antitrust harm.

Moreover, the FTC basically claims that any efficiencies can only be considered “merger-specific” if the parties are able to demonstrate there are no less anticompetitive means to achieve them. It is not enough that they result directly from the merger.

In the case of St. Luke’s, the court determined the defendants’ efficiencies would “improve the quality of medical care” in Nampa, Idaho, but were not merger-specific. The court relied on the FTC’s experts to find that efficiencies such as “elimination of fee-for-service reimbursement” and the movement “to risk-based reimbursement” were not merger-specific, because other entities had potentially achieved similar efficiencies within different provider “structures.” The FTC and their experts did not indicate the success of these other models nor dispute that St. Luke’s would achieve their stated efficiencies. Instead, the mere possibility of potential, alternative structures was enough to overcome merger efficiencies purposed to “move the focus of health care back to the patient.” (The case is currently on appeal and hopefully the Ninth Circuit can correct the lower court’s error).

In contrast to the St. Luke’s case is the recent FTC advisory letter to the Norman Physician Hospital Organization (“Norman PHO”). The Norman PHO proposed a competitive collaboration serving to integrate care between the Norman Physician Association’s 280 physicians and Norman Regional Health System, the largest health system in Norman, Oklahoma. In its analysis of the Norman PHO, the FTC found that the groups could not “quantify… the likely overall efficiency benefits of its proposed program” nor “provide direct evidence of actual efficiencies or competitive effects.” Furthermore, such an arrangement had the potential to “exercise market power.” Nonetheless, the FTC permitted the collaboration. Its decision was instead decided on the basis of Norman PHO’s non-exclusive physician contracting provisions.

It seems difficult if not impossible to reconcile the FTC’s approaches in Boise and Norman. In Norman the FTC relied on only theoretical efficiencies to permit an alliance with significant market power. The FTC was more than willing to accept Norman PHO’s “potential to… generate significant efficiencies.” Such an even-handed approach concerning efficiencies was not applied in analyzing efficiencies in St. Luke’s merger.

The starting point for understanding the FTC’s misguided analysis of efficiencies in St. Luke’s and other merger cases stems from the 2010 Horizontal Merger Guidelines (“Guidelines”).

A recent dissent by FTC Commissioner Joshua Wright outlines the problem – there are asymmetric burdens placed on the plaintiff and defendant. Using the Guidelines, FTC’s merger analysis

embraces probabilistic prediction, estimation, presumption, and simulation of anticompetitive effects on the one hand but requires efficiencies to be proven on the other.

Relying on the structural presumption established in United States v. Philadelphia Nat’l Bank, the FTC need only illustrate that a merger will substantially lessen competition, typically demonstrated through a showing of undue concentration in a relevant market, not actual anticompetitive effects. If this low burden is met, the burden is then shifted to the defendants to rebut the presumption of competitive harm.

As part of their defense, defendants must then prove that any proposed efficiencies are cognizable, meaning “merger-specific,” and have been “verified and do not arise from anticompetitive reductions in output or service.” Furthermore, merging parties must demonstrate “by reasonable means the likelihood and magnitude of each asserted efficiency, how and when each would be achieved…, how each would enhance the merged firm’s ability and incentive to compete, and why each would be merger-specific.”

As stated in a recent speech by FTC Commissioner Joshua Wright,

the critical lesson of the modern economic approach to mergers is that post-merger changes in pricing incentives and competitive effects are what matter.

The FTC’s merger policy “has long been dominated by a focus on only one side of the ledger—anticompetitive effects.” In other words the defendants must demonstrate efficiencies with certainty, while the government can condemn a merger based on a prediction. This asymmetric enforcement policy favors the FTC while requiring defendants meet stringent, unyielding standards.

As the ICLE amicus brief in St. Luke’s discusses, not satisfied with the asymmetric advantage, the plaintiffs in St. Luke’s attempt to “guild the lily” by claiming that efficiencies can only be considered in cases where there is a presumption of competitive harm, perhaps based solely on “first order” evidence, such as increased market shares. Of course, nothing in the law, Guidelines, or sound competition policy limits the defense in that fashion.

The court should consider efficiencies regardless of the level of economic harm. The question is whether the efficiencies will outweigh that harm. As Geoff recently pointed out:

There is no economic basis for demanding more proof of claimed efficiencies than of claimed anticompetitive harms. And the Guidelines since 1997 were (ostensibly) drafted in part precisely to ensure that efficiencies were appropriately considered by the agencies (and the courts) in their enforcement decisions.

With presumptions that strongly benefit the FTC, it is clear that efficiencies are often overlooked or ignored. From 1997-2007, FTC’s Bureau of Competition staff deliberated on a total of 342 efficiencies claims. Of the 342 efficiency claims, only 29 were accepted by FTC staff whereas 109 were rejected and 204 received “no decision.” The most common concerns among FTC staff were that stated efficiencies were not verifiable or were not merger specific.

Both “concerns” come directly from the Guidelines requiring plaintiffs provide significant and oftentimes impossible foresight and information to overcome evidentiary burdens. As former FTC Chairman Tim Muris observed

too often, the [FTC] found no cognizable efficiencies when anticompetitive effects were determined to be likely and seemed to recognize efficiency only when no adverse effects were predicted.

Thus, in situations in which the FTC believes the dominant issue is market concentration, plaintiffs’ attempts to demonstrate procompetitive reasoning are outright dismissed.

The FTC’s efficiency arguments are also not grounded in legal precedent. Courts have recognized that asymmetric burdens are inconsistent with the intent of the Act. As then D.C. Circuit Judge Clarence Thomas observed,

[i]mposing a heavy burden of production on a defendant would be particularly anomalous where … it is easy to establish a prima facie case.

Courts have recognized that efficiencies can be “speculative” or be “based on a prediction backed by sound business judgment.” And in Sherman Act cases the law places the burden on the plaintiff to demonstrate that there are less restrictive alternatives to a potentially illegal restraint – unlike the requirement applied by the FTC that the defendant prove there are no less restrictive alternatives to a merger to achieve efficiencies.

The FTC and the courts should deem worthy efficiencies wherein there is a reasonable likelihood that procompetitive effects will take place post-merger. Furthermore, the courts should not look at efficiencies inside a vacuum. In healthcare, policies and laws, such as the effects of the ACA, must be taken into account. The ACA promotes coordination among providers and incentivizes entities that can move away from fee-for-service payment. In the past, courts relying on the role of health policy in merger analysis have found that efficiencies leading to integrated medicine and “better medical care” are relevant.

In St. Luke’s the court observed that “the existing law seemed to hinder innovation and resist creative solutions” and that “flexibility and experimentation” are “two virtues that are not emphasized in the antitrust law.” Undoubtedly, the current approach to efficiencies makes it near impossible for providers to demonstrate efficiencies.

As Commissioner Wright has observed, these asymmetric evidentiary burdens

do not make economic sense and are inconsistent with a merger policy designed to promote consumer welfare.

In the context of St. Luke’s and other healthcare provider mergers, appropriate efficiency analysis is a keystone of determining a merger’s total effects. Dismissal of efficiencies on the basis of a rigid, incorrect legal procedural structure is not aligned with current economic thinking or a sound approach to incorporate competition analysis into the drive for healthcare reform. It is time for the FTC to set efficiency analysis in the right direction.

In Antitrust & Competition, Constitutional Law, Federal Trade Commission, Health Care, Merger Guidelines, Mergers & Acquisitions, Supreme Court , , , , , , ,
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Swimming Against the Tide: The FTC’s Misguided Antagonism to Health Care Integration

David Balto —  26 August 2014

There is a consensus in America that we need to control health care costs and improve the delivery of health care. After a long debate on health care reform and careful scrutiny of health care markets, there seems to be agreement that the unintegrated, “siloed approach” to health care is inefficient, costly, and contrary to the goal of improving care. But some antitrust enforcers — most notably the FTC — are standing in the way.

Enlightened health care providers are responding to this consensus by entering into transactions that will lead to greater clinical and financial integration, facilitating a movement from volume-based to value-based delivery of care. Any many aspects of the Affordable Care Act encourage this path to integration. Yet when the market seeks to address these critical concerns about our health care system, the FTC and some state Attorneys General take positions diametrically opposed to sound national health care policy as adopted by Congress and implemented by the Department of Health and Human Services.

To be sure, not all state antitrust enforcers stand in the way of health care reform. For example, many states including New York, Pennsylvania and Massachusetts, seem to be willing to permit hospital mergers even in concentrated markets with an agreement for continued regulation. At the same time, however, the FTC has been aggressively challenging integration, taking the stance that hospital mergers will raise prices by giving those hospitals greater leverage in negotiations.

The distance between HHS and the FTC in DC is about 6 blocks, but in healthcare policy they seem to be are miles apart.

The FTC’s skepticism about integration is an old story. As I have discussed previously, during the last decade the agency challenged more than 30 physician collaborations even though those cases lacked any evidence that the collaborations led to higher prices. And, when physicians asked for advice on collaborations, it took the Commission on average more than 436 days to respond to those requests (about as long as it took Congress to debate and enact the Affordable Care Act).

The FTC is on a recent winning streak in challenging hospital mergers. But those were primarily simple cases with direct competition between hospitals in the same market with very high levels of concentration. The courts did not struggle long in these cases, because the competitive harm appeared straightforward.

Far more controversial is when a hospital acquires a physician practice. This type of vertical integration seems precisely what the advocates for health care reform are crying out for. The lack of integration between physicians and hospitals is a core to the problems in health care delivery. But the antitrust law is entirely solicitous of these types of vertical mergers. There has not been a vertical merger successfully challenged in the courts since 1980 – the days of reruns of the TV show Dr. Kildare. And even the supposedly pro-enforcement Obama Administration has not gone to court to challenge a vertical merger, and the Obama FTC has not even secured a merger consent under a vertical theory.

The case in which the FTC has decided to “bet the house” is its challenge to St. Luke’s Health System’s acquisition of Saltzer Medical Group in Nampa, Idaho.

St. Luke’s operates the largest hospital in Boise, and Saltzer is the largest physician practice in Nampa, roughly 20-miles away. But rather than recognizing that this was a vertical affiliation designed to integrate care and to promote a transition to a system in which the provider takes the risk of overutilization, the FTC characterized the transaction as purely horizontal – no different from the merger of two hospitals. In that manner, the FTC sought to paint concentration levels it designed to assure victory.

But back to the reasons why integration is essential. It is undisputed that provider integration is the key to improving American health care. Americans pay substantially more than any other industrialized nation for health care services, 17.2 percent of gross domestic product. Furthermore, these higher costs are not associated with better overall care or greater access for patients. As noted during the debate on the Affordable Care Act, the American health care system’s higher costs and lower quality and access are mostly associated with the usage of a fee-for-service system that pays for each individual medical service, and the “siloed approach” to medicine in which providers work autonomously and do not coordinate to improve patient outcomes.

In order to lower health care costs and improve care, many providers have sought to transform health care into a value-based, patient-centered approach. To institute such a health care initiative, medical staff, physicians, and hospitals must clinically integrate and align their financial incentives. Integrated providers utilize financial risk, share electronic records and data, and implement quality measures in order to provide the best patient care.

The most effective means of ensuring full-scale integration is through a tight affiliation, most often achieved through a merger. Unlike contractual arrangements that are costly, time-sensitive, and complicated by an outdated health care regulatory structure, integrated affiliations ensure that entities can effectively combine and promote structural change throughout the newly formed organization.

For nearly five weeks of trial in Boise St. Luke’s and the FTC fought these conflicting visions of integration and health care policy. Ultimately, the court decided the supposed Nampa primary care physician market posited by the FTC would become far more concentrated, and the merger would substantially lessen competition for “Adult Primary Care Services” by raising prices in Nampa. As such, the district court ordered an immediate divestiture.

Rarely, however, has an antitrust court expressed such anguish at its decision. The district court readily “applauded [St. Luke’s] for its efforts to improve the delivery of healthcare.” It acknowledged the positive impact the merger would have on health care within the region. The court further noted that Saltzer had attempted to coordinate with other providers via loose affiliations but had failed to reap any benefits. Due to Saltzer’s lack of integration, Saltzer physicians had limited “the number of Medicaid or uninsured patients they could accept.”

According to the district court, the combination of St. Luke’s and Saltzer would “improve the quality of medical care.” Along with utilizing the same electronic medical records system and giving the Saltzer physicians access to sophisticated quality metrics designed to improve their practices, the parties would improve care by abandoning fee-for-service payment for all employed physicians and institute population health management reimbursing the physicians via risk-based payment initiatives.

As noted by the district court, these stated efficiencies would improve patient outcomes “if left intact.” Along with improving coordination and quality of care, the merger, as noted by an amicus brief submitted by the International Center for Law & Economics and the Medicaid Defense Fund to the Ninth Circuit, has also already expanded access to Medicaid and uninsured patients by ensuring previously constrained Saltzer physicians can offer services to the most needy.

The court ultimately was not persuaded by the demonstrated procompetitive benefits. Instead, the district court relied on the FTC’s misguided arguments and determined that the stated efficiencies were not “merger-specific,” because such efficiencies could potentially be achieved via other organizational structures. The district court did not analyze the potential success of substitute structures in achieving the stated efficiencies; instead, it relied on the mere existence of alternative provider structures. As a result, as ICLE and the Medicaid Defense Fund point out:

By placing the ultimate burden of proving efficiencies on the Appellants and applying a narrow, impractical view of merger specificity, the court has wrongfully denied application of known procompetitive efficiencies. In fact, under the court’s ruling, it will be nearly impossible for merging parties to disprove all alternatives when the burden is on the merging party to oppose untested, theoretical less restrictive structural alternatives.

Notably, the district court’s divestiture order has been stayed by the Ninth Circuit. The appeal on the merits is expected to be heard some time this autumn. Along with reviewing the relevant geographic market and usage of divestiture as a remedy, the Ninth Circuit will also analyze the lower court’s analysis of the merger’s procompetitive efficiencies. For now, the stay order is a limited victory for underserved patients and the merging defendants. While such a ruling is not determinative of the Ninth Circuit’s decision on the merits, it does demonstrate that the merging parties have at least a reasonable possibility of success.

As one might imagine, the Ninth Circuit decision is of great importance to the antitrust and health care reform community. If the district court’s ruling is upheld, it could provide a deterrent to health care providers from further integrating via mergers, a precedent antithetical to the very goals of health care reform. However, if the Ninth Circuit finds the merger does not substantially lessen competition, then precompetitive vertical integration is less likely to be derailed by misapplication of the antitrust laws. The importance and impact of such a decision on American patients cannot be understated.

In Antitrust & Competition, Federal Trade Commission, Health Care, International Center for Law & Economics, Merger Guidelines, Mergers & Acquisitions , , , , ,
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McWane: Structure Isn’t Enough

David Balto —  21 January 2014

The following is the third in a series of guest posts by David Balto about the FTC’s McWane case.

A particularly unsettling aspect of the FTC’s case against McWane is the complaint counsel’s heavy (and seemingly exclusive) reliance on structural factors to prove its case. The FTC has little or no direct evidence of price communications and no econometric evidence suggesting collusion, and has instead spent a good deal of time trying to show that the market is susceptible to collusion. What makes the FTC’s administrative case so unsettling is that the structural factors they rely on are true of any oligopoly and, in federal courts across the country, are insufficient as a matter of law to raise an inference of conspiracy.

When there are a small number of actors in a market they naturally act and react differently than markets with many competitors. As an example, imagine it’s the final chess tournament between two capable opponents. At one point of the game one player makes a move knowing that it will likely force her opponent to make a move that will later work to her advantage. The opponent makes this move and the referees stop the match. The referees say the opponent moved in a way that was advantageous to the player who proves this game is rigged. The referees further explain that because there are only the two of them playing and because they know each other that this game of chess is susceptible to cheating. Because the game is susceptible to cheating, the referees declare, the evidence that the opponent made a move advantageous to player is all the evidence the referees need to stop the game.

Obviously the situation described in the chess example would never occur. It is common in two party games for one player to force another player into taking a particular move. No referee would stop a match with such flimsy evidence. However, the FTC seeks to find McWane liable of collusion under similar circumstances.

Ductile iron pipe fittings (DIPF) are commodities and the DIPF market is an oligopoly with only three major players:  McWane, Sigma and Star. Each DIPF supplier constantly tries to monitor its rivals’ prices because if a competitor undercuts it, its sales volume will fall. Each DIPF supplier is also susceptible to rising costs caused by market conditions and has similar motivations to raise prices to account for rising costs. Complaint counsel argues that these characteristics make the fittings market “susceptible” or “conducive” to collusion, which shows a motive to conspire.  The Administrative Law Judge (ALJ) did not find complaint counsel’s argument persuasive.

The collusion case against McWane came down to whether there was an agreement among competitors to curtail project pricing. As such, the ALJ sought to determine whether or not the evidence shows:  (1) a prior understanding among the Suppliers, including McWane, that each Supplier would curtail Project Pricing; (2) a commitment to one another to curtail Project Pricing; (3) a restricted freedom of action and sense of obligation to one another to curtail Project Pricing, and (4) an actual reduction in the amount or level of Project Pricing. Consistent with prevailing federal court caselaw, the ALJ demanded evidence indicating an “actual, manifest agreement” and found that evidence lacking.

Unfortunately for complaint counsel, the evidence it put on is also suggestive of interdependence and conscious parallelism among oligopolists, which are not violations of the law. It was in McWane’s interests to get its competitors to curtail project pricing so it could better determine the real prices it needed to “further its own legitimate business interests of increasing volume . . . in order to beat prices being offered by its competitors, which is a procompetitive purpose.”. McWane used its position as a price leader to make a move that it hoped would force McWane’s competitors to reduce project pricing. Despite large raw material cost increases, McWane refused to raise published list prices to the high levels Sigma and Star had announced, and it set its regional multipliers in such a way that would pressure those competitors to match its lower multipliers and, it hoped, to reduce their project pricing.

McWane’s strategy did not require or lead to an “actual, manifest agreement” on multipliers or project pricing, as complaint counsel alleges. The ALJ found that “If Sigma and Star declined to adopt McWane’s new multipliers, the new multipliers could be easily withdrawn or revised.” The ALJ determined that McWane’s move was not irrational because McWane could still easily react based on the behavior of its competitors. Indeed, the ALJ found that it was “undisputed that Project Pricing did not stop,” and found no evidence that Project Pricing declined at all.

On the collusion issue, the ALJ rightly found that price maneuvering in an oligopoly is not a violation without sufficient evidence to show there was an actual, manifest agreement. If the FTC were to do so it would open many markets up to additional risk. It would also be impossible to craft a remedy without grossly interfering with the normal operation of the market. In this, the ALJ reiterated the sentiment of the First Circuit – “How does one order a firm to set its prices without regard to the likely reactions of its competitors?”

The FTC Commissioners should not hold a company guilty of collusion simply for being a part of an oligopoly. As the ALJ stated – “accepting Complaint Counsel’s position that oligopolistic interdependence is a ‘plus’ factor would, in effect, foist a nefarious motive upon the Suppliers merely because they conduct their business within an oligopoly market. This is not the law.” The ALJ was right, and it would be inconsistent with well-established federal court caselaw to rule otherwise.  The FTC should not be subject to one rule in federal court, but another for its own internal administrative court.

In Administrative Law, Antitrust & Competition, Federal Trade Commission, Monopolization, Regulation, Truth on the Market
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McWane: Why Have An Administrative Law Judge?

David Balto —  17 January 2014

The following is the second in a series of guest posts by David Balto about the FTC’s McWane case.

Two modest offices on the first floor of the FTC building are occupied by the FTC Administrative Law Judge and his staff.  Of all of the agencies with an ALJ, the FTC’s operation must be the smallest.  The ALJ handles only a handful of trials each year.  In the past, the FTC ALJ operation has gathered little to no attention.  But in recent years, with renewed focus on administrative litigation and tight litigation deadlines, FTC administrative litigation has become a rocket docket of sorts.

But there is renewed attention for another reason.  As I have written elsewhere the FTC is on a 19-year streak of always finding violations in its administrative litigation.  In many instances that has required it to reverse an ALJ.  When the Commission reverses on the law, that is not exceptional.  But in those cases where the Commission has taken a different view of the facts, there is far greater controversy.  Although the Commission does analyze the facts de novo, the ALJ has conducted the trial, listened to the testimony, watched the witnesses and is in the best position to assess credibility and determine the facts.  The Commission’s differing view of the facts in cases such as Rambus and Schering led appellate courts to treat the FTC decision with extreme skepticism.  If the FTC is going to second guess the ALJ’s factual findings, which are based on his first-hand observation of the witnesses and review of the documents, why do we have ALJs?

This post addresses that issue by looking at the factual findings of the ALJ in the McWane case (for an introduction of the McWane case please see my previous post). The ALJ in the McWane case wrote an extensive 235 pages of factual findings. In the interest of brevity, I will only be discussing the collusion findings.  My goal is to illustrate how difficult it will be to reverse some of these findings, and if reversed, the problems it will likely present on appeal.

To understand the FTC’s collusion claims it is important to first understand how fittings are priced. Fitting prices start with published list prices. No one buys off published prices.  The suppliers publish regional multipliers that provide discounts off the published list price. The ALJ found that “[d]istributors prefer that [f]ittings suppliers like McWane, Sigma, and Star have identical list prices because it is easier for [d]istributors to compare the suppliers’ multipliers and discounts to determine net prices.” Suppliers also have a variety of mechanisms to discount prices below the multiplier price in order to compete for bids. Chief among these is the project price, which is a discounted price for an entire project or job or for a single order. It is easy for competitors to find out each other’s list prices and multipliers from their customers which are often large and aggressive buyers who bargain down prices. However, discounts beyond the multipliers are often hidden and hard to discover by competitors.

The ALJ found the fittings market to be an oligopoly. McWane, Sigma, and Star are constantly looking for, and reacting to, changes in each other’s pricing. Much of this competitive information was received through customers and it was known that any letter sent to a customer would end up in the hands of a competitor. The ALJ found that while “[c]ustomer letters served to communicate to competitors, as well as customers[,]”the “substantial evidence” showed that the parties priced independently at all times and McWane routinely priced below its competitors.

Beginning in 2007, “the [f]ittings industry experienced a period of declining demand, increased price competition resulting in price erosion, and increased costs.” The ALJ found that during this period McWane’s main concern was to increase sales volume in order to reduce excess inventory and keep its foundries open. The ALJ also found that McWane’s net pricing was not keeping up with cost inflation. The cost of doing business overseas, primarily in China, was also increasing, which impacted all fittings suppliers equally. Every supplier was looking to increase pricing but the suppliers were also aware that any increase would have to be followed to stick.

McWane used these conditions to allegedly come up with a strategy, which later became the basis for the FTC’s complaint, to “narrow the range between the published price and actual prices and thereby give his competitors less ‘headroom,’ within which Star and Sigma could maneuver to undercut McWane on price.” Instead of following Star and Sigma on their very large list price increases, McWane kept its list prices steady and raised some its multipliers, but to a much lower amount than Sigma and Star’s list price increases. McWane also announced an intention to stop project pricing through customer letters, according to the FTC. Project pricing hides the real prices of fittings. McWane’s goal was to make prices more transparent so that it could better compete on price but “McWane knew internally that in order to meet its objectives of increasing volume and share, it would have to Project Price.”

The FTC also had a problem with the beginning of a fittings trade group called DIFRA. The FTC’s claim was that DIFRA allowed the fittings companies to share sensitive competitive data. McWane, Star and Sigma would report “tons-shipped data” to DIFRA for their fittings sales. The ALJ found that the data gathered by DIFRA’s accountants “did not distinguish between Domestic Fittings and non-domestic Fittings” and “did not include or reveal any sales Prices.” The ALJ also found that “no DIFRA member was permitted to review the tons-shipped data of any other member; the reports revealed only the aggregate total tons-shipped during the relevant reporting period.” This DIFRA data was used by each supplier to determine their market share in order to plan future business strategies.

The FTC believed that McWane’s strategy, DIFRA, and other activities were collusive actions to stabilize and raise prices. The FTC saw the alleged elimination of project pricing and sharing of aggregated volume data as mechanisms to enforce a cartel and prevent cheating. However, the ALJ did not find these activities to amount to anticompetitive behavior – there was no smoking gun that turned these activities with procompetitive justifications into an antitrust violation. The data DIFRA provided had procompetitive uses including an instance where it “helped McWane decide, in June 2008, to choose the low end of the 8% to 12% range of multiplier increases” because the report showed McWane was “continuing to lose market share.” The ALJ also found that the data did not suggest a reduction in job pricing. The expert in the trial, which the ALJ found “offered credible and persuasive expert opinion, based on actual prices,” found “no economic evidence that the price changes in January or June of 2008 were coordinated, or that there was an agreement to reduce job pricing as would be reflected in a decrease in price variance; that there was economic evidence that contradicted a conclusion that prices were raised anticompetitively in the Fittings market; and that the pattern of sales and inventory contradicts the notion of quantity withholding, as would be needed to effect a price increase.” The ALJ also found that McWane’s witness “credibly testified that McWane’s goal going into 2008 was primarily to increase volume, rather than price,” and that “[t]he decline in McWane’s pricing (F. 940), given the rise in input costs (F. 951), is inconsistent with a conspiracy and consistent with independent pricing behavior.”

The ALJ ultimately found that the government’s collusion claims amounted to nothing more than “weak” “unsupported speculation” and that its “daisy chain of assumptions fails to support or justify an evidentiary inference of any unlawful agreement involving McWane.” The FTC will have trouble overcoming these findings if it chooses to overturn the ALJ’s dismissal of the collusion claims. For the Commissioners to do so would essentially be making different credibility assessments than the ALJ, even though they weren’t present for the trial. If these ALJ findings are so easily overturned it would bring into question why an ALJ is needed in the first place.

In Administrative Law, Antitrust & Competition, China, Federal Trade Commission, International, Monopolization, Regulation, Truth on the Market
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FTC at a crossroads: The McWane case

David Balto —  13 January 2014

The following is the first in a series of guests posts by David Balto about the FTC’s McWane case.

Anyone familiar with the antitrust newstream realizes there is a tremendous amount of controversy about the Federal Trade Commission’s administrative litigation process. Unlike the Antitrust Division which fights its litigation battles in Federal Court, the FTC has a distinct home court advantage. FTC antitrust cases are typically litigated administratively with a trial conducted before an FTC administrative law judge, who issues an initial decision, followed with an appeal to the full Commission for a final decision. I have authored a couple of recent articles as have others that question the fairness of the FTC acting as both prosecutor and judge. These concerns have only been amplified since for the last 19 years the FTC has always found a violation of law. As one Congressman noted the FTC has “an unbeaten streak that Perry Mason would envy.”

All of this will come to a head later this month in an FTC case against McWane, Inc., a modest firm that makes ductile iron pipe fittings (DIPF). In this case the FTC brought a complaint against McWane alleging collusion with competitors to stabilize and raise prices and exclusion of competitors in the domestically manufactured DIPF market. The case was tried like greased lightning – it went from complaint to trial in 9 months. The trial before the administrative law judge (ALJ) involved over 2,000 exhibits, 16 live witnesses and 53 total witnesses, 25 trial days, 6,045 pages of trial transcript, and culminated in a 464-page decision – possibly the longest FTC decision in history. Ultimately, the ALJ split his decision and found for McWane on the collusion counts and for the FTC on the exclusion counts. Both parties have appealed and the case is currently under consideration by the Commission. The case was argued before the Commission on August 22, 2013, and a decision by the Commission is expected by January 25.

The McWane case provides an excellent lens to examine where the FTC may be headed in administrative litigation and the policing of dominant firm conduct. For this reason I will be writing a series of posts explaining the case and why a finding of a violation may be a risky path for the development of the law on collusion and exclusion, and what proof is needed to show such violations. This first article will explain the state of the market that led to the filing of a complaint.

McWane is a producer of domestically manufactured DIPF, which are used to join pipe in pressurized water transportation systems. DIPF can join pipe in straight lines or change, divide or direct the flow of water. DIPF are usually sold to municipal and regional water authorities through independent wholesale distributors. DIPF are commodity products that are produced to American Water Works Association standards. This makes all DIPF that meet the standards, whether foreign or domestically produced, completely interchangeable.

The DIPF market used to be dominated by domestic producers; however that has changed over the past 20 years. Project managers and municipalities can stipulate on their specifications whether the fittings for a particular project are to be domestically produced, imported, or open to all bids. Since the mid-1980s cheap foreign fittings and dumping has caused most of these specifications to be flipped from domestic-only to open. The period of 2003-2008 saw the biggest decline in domestic DIPF – from about 70% to 15-20%. This led many domestic fittings producers to either dramatically reduce their production or exit the market entirely. The International Trade Commission unanimously determined in 2003 that a flood of cheap fittings from China was causing “market disruption” and “material injury” to domestic fittings producers. McWane became the last domestic DIPF producer with a full-line foundry dedicated to DIPF in the United States and that foundry is only operating at 30% capacity, which puts it in danger of being closed. McWane was previously forced to shut down its other U.S. foundry and open a foundry in China, measures taken to compete with the low cost of foreign production.

There are still some specifications that require domestically produced fittings. This may be due to preference (ex. patriotism) or legal rules, but both of these can (and did) change with frequency to permit the purchase of imported fittings. In addition, the “Buy American” provisions of the American Recovery and Reinvestment Act (ARRA) did create a brief increase in the demand of domestically produced fittings. However, the numerous waivers and temporary nature meant that the sale of domestic fittings only rose to about a third of all sales before falling back to their pre-ARRA levels when ARRA expired in 2010. Domestic-only specifications and the ARRA period encouraged foreign fittings companies to consider producing DIPF products domestically. Star entered shortly after the passage of ARRA and Sigma entered into a Master Distribution Agreement (MDA) with McWane to supply domestic fittings during the ARRA period. It was these conditions that produced the FTC complaint.

McWane’s actions to keep its domestic foundry open led to the FTC complaint. McWane’s rebate program, designed to help it increase production at its foundry, became the basis of the FTC’s claim that McWane was excluding Star from the market. McWane’s MDA agreement with Sigma, which also helped expand its reach to Sigma’s customer base and to increase its domestic foundry production, was seen by the FTC as excluding Sigma from the market. McWane was also charged with colluding with Star, who successfully entered the market, to raise and stabilize prices.

The FTC’s complaint is divided into two parts with counts 1-3 alleging collusion and counts 4-7 alleging exclusionary actions by McWane. The collusion counts charge conspiracy to restrain price competition in the relevant Fittings market (Count One); conspiracy to exchange competitively sensitive sales information (Count Two); and invitation to collude (Count Three). The exclusionary counts charge that the MDA was an agreement in restraint of trade (Count Four); a conspiracy between McWane and Sigma to monopolize the Domestic Fittings market (Count Five); exclusionary acts constituting willful practices to acquire, enhance, or maintain monopoly power in the relevant Domestic Fittings market (Count Six); and specific intent to monopolize the Domestic Fittings market (Count Seven). The ALJ dismissed counts 1-3, finding that the FTC’s conspiracy allegations were “weak,” “unverified,” “unpersuasive,” “strained,” and “unsupported,” amounting to a “daisy chain of assumptions.” The ALJ went on to find that Star, who was a “a less efficient supplier” than McWane, “clearly” entered the Domestic Fittings market in 2009, and that its market share went “from zero to almost 10% in 2011.” He also found that “Sigma was in a precarious position overall in financial terms” and “regardless of whether Sigma had the financial capability to produce Domestic Fittings . . . it did not have the time required to do so” before the end of the ARRA period, but nonetheless found that counts 4-7 were proven by a preponderance of the evidence.

The McWane case is unusual for several reasons as I will describe in my future posts. The FTC alleges collusion to raise and stabilize prices and exclusionary conduct but the time period of any alleged wrongful conduct seems incredibly short. The FTC alleges that the victim of McWane’s supposed exclusionary tactics, Star, also conspired with McWane to raise prices – a contradiction that FTC Commissioner Rosch had trouble with. The FTC relies heavily on a domestic market definition even though there is strong evidence that foreign competition had driven all domestic suppliers out of the market except for McWane and that any domestic only market, if it exists, does not appear to be large enough or stable enough to support an industry. Finally, The FTC relies on structural and plus factors to prove collusion rather than direct evidence of price agreements or communications or economic evidence and analyses showing any supra-competitive price effects.

In my next article I will explain the ALJ’s factual findings in relation to the alleged violations and pose some of the challenges the Commission faces.

In Administrative Law, Antitrust & Competition, Antitrust Division, China, Exclusionary Conduct, Federal Trade Commission, International, International Trade, Justice Department, Market Definition, Monopolization, Regulation, Section 5, Truth on the Market
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