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A couple of weeks ago, I posted a blog discussing the FTC’s complaint against Ovation.  One of the interesting factors of that complaint was the FTC’s decision to seek disgorgement of profits allegedly improperly gained as a result of the challenged acquisition.  The FTC has only infrequently sought disgorgement in antitrust matters and it is interesting that it has chosen to do so in this consummated merger challenge.  Seeking disgorgement raises several practical issues as to the methods the FTC might use to estimate the appropriate amount of disgorgement as well as of course the policy issues as to when disgorgement is appropriate and what implication this has for follow-on suits that might arise should the FTC be successful.

The practical issues associated with seeking disgorgement fall of course in the well-trodden landscape of damages in antitrust cases.  In this case, the FTC will likely argue that the appropriate level of disgorgement is the consumer overcharge that allegedly occurred as a result of the merger.  Of course, this is very similar to what occurs in many antitrust cases, particularly when the plaintiffs are customers.  In such cases, damages experts generally gather information on what actual prices have been during the period and in the geographic area allegedly implicated by the challenged behavior.  The key challenge then is developing a reasonable estimate as to what the price would have been “but-for” the challenged behavior.  Economists use many methods for these estimates – for example, using prices outside the impacted geographic area or prices before or after the alleged behavior occurred as benchmarks.  This frequently requires the use of econometrics or other statistical techniques to control for other factors that might impact pricing.  The key areas of dispute are generally whether the appropriate benchmark is being used and whether other factors are taken into account.  In this case, a key issue is likely to be whether the pre-merger price of $35 is the relevant benchmark or not.

Price overcharges are not of course the only measure of damages in antitrust cases – particularly when competitors bring monopolization cases, lost profits for the competitor may also be used as the measure of damages.  Moreover, even when overcharges are the relevant measure, issues can arise as to overcharges at which level of the supply chain and who is likely to be damaged.

Of interest in damages matters generally (and in this case in particular) is that damages almost always relate to overcharges on sales that did occur but only infrequently are there attempts to estimate what additional damages might exist a result of sales that did not occur.  Simple demand theory would of course indicate that higher prices lead to lower sales.  Consumers who would have made sales at lower prices thus lose the value they place on the product above the “but-for” price.  For economists, it is these lost sales that create the economic inefficiency associated with from anticompetitive behavior but as noted damages generally do not take into account these lost sales – and for good reason.  First, estimating these lost sales requires an estimate of demand, which can often be very difficult.  Second, the damages associated with lost sales generally will be small relative to the overcharges on actual sales.  Third, sellers of course give up potential profits on those sales and one must consider whether these “lost” profits should also be taken into account.  Fourth, identifying who are the “victims” who did not purchase is difficult.

Of interest, is whether in a disgorgement case, it would be appropriate to try to take into account these issues since the government in theory should be going after all damages and does not have to worry about identifying the precise victims.  Of course, all of the other issues mentioned above still hold making it a challenge even such matters.  However, in this case, the alleged overcharge is so large that one wonders whether there would be some sizeable amount of lost sales (unless demand is very inelastic).  Certainly, one might think that the FTC would try to play up the specter in the liability part of the case that the overcharges might mean less care for premature babies.  It will be interesting to see if the FTC at least raises this issue – even if it does not try to specifically quantify the harm.

RELATED POSTS:  Josh Wright, No Ovation for FTC’s Latest Enforcement Theory

On December 16, 2008, the FTC filed a complaint against Ovation Pharmaceuticals that challenged its 2006 acquisition of the drug Neoprofen from Abbott.  (The acquisition had fallen beneath the HSR thresholds and thus was not subject to an HSR investigation prior to consummation).  While the complaint and case itself raises some interesting issues which I will discuss below, the concurring statements of Commissioners Leibowitz and Rosch, particularly the theory laid out in Commissioner Rosch’s statement raises more interesting (and potentially troubling) issues – in particular the potential to substantially expand the scope of Section 7.

The complaint involves the acquisition by Ovation of its alleged only other competitor in the sale of drugs used to treat patent ductus arteriosis (PDA), a potentially life threatening heart condition in severely underweight newborn babies.   Assuming the facts are as presented in the case (which I am sure defendants will contest), the complaint itself does not raise complex antitrust issues.  Given the alleged facts, the acquisition would essentially be a merger to monopoly (at least until a generic version of Ovation’s product is on the market assuming one eventually enters) without any other projects apparently in the pipeline to treat this disease (perhaps not surprisingly given the relatively small number of patients per year).

Despite these seemingly routine antitrust issues, this case would be the first time the FTC has challenged in court an acquisition that at least at the time of the transaction involved potential competition.  It is unclear, however, whether this case will provide much guidance in this area with regard to the types of matters the FTC routinely investigates and challenges in pharmaceutical acquisitions.  First, this is an alleged merger to monopoly.  Second, one of the products was already on the market and the other was fairly close to FDA approval (apparently already completing Phase III trials).  Thus, the potential competition was relatively close to actually competition.  Third, with no other products in the pipeline, the case raises no issue of whether the market would be narrower than all drugs used to treat a particular disease.  However, there is likely to be at least some issue as to whether the products would be very close substitutes.  Fourth, with hindsight, the drug not yet on the market was brought to market fairly quickly after the transaction and thus no tricky issues about innovation competition and whether one product would be cancelled or delayed are raised.  Thus, if anything this appears to be a “poster child” for a potential competition case (particularly given the allegations about the increases in price).  The FTC routinely investigates and challenges potential competition theories via consent matters that involve less relatively “clear cut” issues and thus it is not clear that will help inform how courts would view such cases.

Of more potential interest is the fact that the FTC is making an important part of its argument the alleged increase in price and is seeking disgorgement of profits gained from the transaction.  The FTC is alleging that after the transaction Ovation raised the price of its own product (which was already on the market) from $36/vial to $500/vial – a huge increase.  The challenge the FTC is likely to face and where economic testimony is likely to play a central role (as it did in Evanston), however, is attributing some or all of that price increase to the merger.  There are at least reasons to think that there might be other reasons for the price increase.  First, one would wonder why the threat of competition would keep prices low prior to the competitive drug actually being approved (presumably Ovation would have wanted to charge higher prices when it could and only drop prices when a new product was on the market particularly if the barriers to entry exist as are alleged in the Complaint).  Second, I cannot think of an economic model where a duopoly would lead to a price less than 10% of the monopoly price when the two products involved are branded, are not likely perfect substitutes and almost certainly would not be sold only based on price.  Thus, determining how much of the price increase can be attributed to the transaction may be challenging for the FTC and this issue will likely be a central role for the economic testimony (although such testimony will almost certainly include other issues as well).

This leads us to Commissioner Rosch’s theory (which is endorsed by Commissioner Leibowitz).  Commissioner Rosch would also challenge Ovation’s original purchase of its product (Indocin) from Merck even though at that time Ovation had no horizontal or vertical relationship with the PDA market because Ovation raised the price when Merck had kept the price low.  Ovation’s acquisition only changed who marketed and priced the product, not the number of competitors.  In fact, at that time, Merck had a monopoly in the alleged market and this was unchanged by the acquisition.  Commissioner Rosch’s theory is that something must have constrained Merck from charging higher prices for its product (he theorizes that perhaps it could be the reputation effects on other products in their portfolio) whereas Ovation did face such constraints and thus raised prices.  Thus Commissioner Rosch’s theory appears to be that because the acquisition changed the incentives of the firm owning the monopoly such that it would fully exploit that monopoly this can be a Section 7 violation.

This theory seems far removed from the way we normally analyze merger cases and potentially would have the effect of raising antitrust concerns or at least an investigation with almost any transaction where one firm might be argued to have market power even though the structure of the industry (horizontally or vertically) is unchanged.  While Commissioner Rosch highlights some potentially limiting principles, such as the fact that this is a consummated transaction, it is hard to see how this fact connects to why the transaction might violate Section 7 (versus potentially discretion as when to pursue the theory).  Regardless of whether the merger was consummated, as discussed above, one would presumably need to show that the merger caused the price increase rather than other factors which is likely to be challenging, particularly in a non-horizontal deal.

Moreover, antitrust has generally not been about the exploitation of market power (i.e., charging above competitive prices) but rather the inappropriate acquisition or maintenance of that power.   This focus has been for good reason as it prevents antitrust courts and regulators from the business of determining competitive prices and when exploitation of market power is a good thing (because it is the rewards for innovation for example) or a bad thing.  Moreover, there is nothing that necessarily limits this theory to a merger but could theoretically be applied to anything that might allow a monopolist to raise price.  While this could be a boon to economists it is not clear it is good policy.   The FTC complaint does not espouse this theory so apparently some at the agency do not agree with Commissioner Rosch’s point of view (or they wished to keep the complaint more straightforward for the second acquisition).  It will be interesting to see if this theory begins to appear in any other merger investigations.