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A debate has broken out among the four sitting members of the Federal Trade Commission (FTC) in connection with the recently submitted FTC Report to Congress on Privacy and Security. Chair Lina Khan argues that the commission “must explore using its rulemaking tools to codify baseline protections,” while Commissioner Rebecca Kelly Slaughter has urged the FTC to initiate a broad-based rulemaking proceeding on data privacy and security. By contrast, Commissioners Noah Joshua Phillips and Christine Wilson counsel against a broad-based regulatory initiative on privacy.

Decisions to initiate a rulemaking should be viewed through a cost-benefit lens (See summaries of Thom Lambert’s masterful treatment of regulation, of which rulemaking is a subset, here and here). Unless there is a market failure, rulemaking is not called for. Even in the face of market failure, regulation should not be adopted unless it is more cost-beneficial than reliance on markets (including the ability of public and private litigation to address market-failure problems, such as data theft). For a variety of reasons, it is unlikely that FTC rulemaking directed at privacy and data security would pass a cost-benefit test.

Discussion

As I have previously explained (see here and here), FTC rulemaking pursuant to Section 6(g) of the FTC Act (which authorizes the FTC “to make rules and regulations for the purpose of carrying out the provisions of this subchapter”) is properly read as authorizing mere procedural, not substantive, rules. As such, efforts to enact substantive competition rules would not pass a cost-benefit test. Such rules could well be struck down as beyond the FTC’s authority on constitutional law grounds, and as “arbitrary and capricious” on administrative law grounds. What’s more, they would represent retrograde policy. Competition rules would generate higher error costs than adjudications; could be deemed to undermine the rule of law, because the U.S. Justice Department (DOJ) could not apply such rules; and innovative efficiency-seeking business arrangements would be chilled.

Accordingly, the FTC likely would not pursue 6(g) rulemaking should it decide to address data security and privacy, a topic which best fits under the “consumer protection” category. Rather, the FTC presumably would most likely initiate a “Magnuson-Moss” rulemaking (MMR) under Section 18 of the FTC Act, which authorizes the commission to prescribe “rules which define with specificity acts or practices which are unfair or deceptive acts or practices in or affecting commerce within the meaning of Section 5(a)(1) of the Act.” Among other things, Section 18 requires that the commission’s rulemaking proceedings provide an opportunity for informal hearings at which interested parties are accorded limited rights of cross-examination. Also, before commencing an MMR proceeding, the FTC must have reason to believe the practices addressed by the rulemaking are “prevalent.” 15 U.S.C. Sec. 57a(b)(3).

MMR proceedings, which are not governed under the Administrative Procedure Act (APA), do not present the same degree of legal problems as Section 6(g) rulemakings (see here). The question of legal authority to adopt a substantive rule is not raised; “rule of law” problems are far less serious (the DOJ is not a parallel enforcer of consumer-protection law); and APA issues of “arbitrariness” and “capriciousness” are not directly presented. Indeed, MMR proceedings include a variety of procedures aimed at promoting fairness (see here, for example). An MMR proceeding directed at data privacy predictably would be based on the claim that the failure to adhere to certain data-protection norms is an “unfair act or practice.”

Nevertheless, MMR rules would be subject to two substantial sources of legal risk.

The first of these arises out of federalism. Three states (California, Colorado, and Virginia) recently have enacted comprehensive data-privacy laws, and a large number of other state legislatures are considering data-privacy bills (see here). The proliferation of state data-privacy statutes would raise the risk of inconsistent and duplicative regulatory norms, potentially chilling business innovations addressed at data protection (a severe problem in the Internet Age, when business data-protection programs typically will have interstate effects).

An FTC MMR data-protection regulation that successfully “occupied the field” and preempted such state provisions could eliminate that source of costs. The Magnuson–Moss Warranty Act, however, does not contain an explicit preemption clause, leaving in serious doubt the ability of an FTC rule to displace state regulations (see here for a summary of the murky state of preemption law, including the skepticism of textualist Supreme Court justices toward implied “obstacle preemption”). In particular, the long history of state consumer-protection and antitrust laws that coexist with federal laws suggests that the case for FTC rule-based displacement of state data protection is a weak one. The upshot, then, of a Section 18 FTC data-protection rule enactment could be “the worst of all possible worlds,” with drawn-out litigation leading to competing federal and state norms that multiplied business costs.

The second source of risk arises out of the statutory definition of “unfair practices,” found in Section 5(n) of the FTC Act. Section 5(n) codifies the meaning of unfair practices, and thereby constrains the FTC’s application of rulemakings covering such practices. Section 5(n) states:

The Commission shall have no authority . . . to declare unlawful an act or practice on the grounds that such an act or practice is unfair unless the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition. In determining whether an act or practice is unfair, the Commission may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations may not serve as a primary basis for such determination.

In effect, Section 5(n) implicitly subjects unfair practices to a well-defined cost-benefit framework. Thus, in promulgating a data-privacy MMR, the FTC first would have to demonstrate that specific disfavored data-protection practices caused or were likely to cause substantial harm. What’s more, the commission would have to show that any actual or likely harm would not be outweighed by countervailing benefits to consumers or competition. One would expect that a data-privacy rulemaking record would include submissions that pointed to the efficiencies of existing data-protection policies that would be displaced by a rule.

Moreover, subsequent federal court challenges to a final FTC rule likely would put forth the consumer and competitive benefits sacrificed by rule requirements. For example, rule challengers might point to the added business costs passed on to consumers that would arise from particular rule mandates, and the diminution in competition among data-protection systems generated by specific rule provisions. Litigation uncertainties surrounding these issues could be substantial and would cast into further doubt the legal viability of any final FTC data protection rule.

Apart from these legal risk-based costs, an MMR data privacy predictably would generate error-based costs. Given imperfect information in the hands of government and the impossibility of achieving welfare-maximizing nirvana through regulation (see, for example, here), any MMR data-privacy rule would erroneously condemn some economically inefficient business protocols and disincentivize some efficiency-seeking behavior. The Section 5(n) cost-benefit framework, though helpful, would not eliminate such error. (For example, even bureaucratic efforts to accommodate some business suggestions during the rulemaking process might tilt the post-rule market in favor of certain business models, thereby distorting competition.) In the abstract, it is difficult to say whether the welfare benefits of a final MMA data-privacy rule (measured by reductions in data-privacy-related consumer harm) would outweigh the costs, even before taking legal costs into account.

Conclusion

At least two FTC commissioners (and likely a third, assuming that President Joe Biden’s highly credentialed nominee Alvaro Bedoya will be confirmed by the U.S. Senate) appear to support FTC data-privacy regulation, even in the absence of new federal legislation. Such regulation, which presumably would be adopted as an MMR pursuant to Section 18 of the FTC Act, would probably not prove cost-beneficial. Not only would adoption of a final data-privacy rule generate substantial litigation costs and uncertainty, it would quite possibly add an additional layer of regulatory burdens above and beyond the requirements of proliferating state privacy rules. Furthermore, it is impossible to say whether the consumer-privacy benefits stemming from such an FTC rule would outweigh the error costs (manifested through competitive distortions and consumer harm) stemming from the inevitable imperfections of the rule’s requirements. All told, these considerations counsel against the allocation of scarce FTC resources to a Section 18 data-privacy rulemaking initiative.

But what about legislation? New federal privacy legislation that explicitly preempted state law would eliminate costs arising from inconsistencies among state privacy rules. Ideally, if such legislation were to be pursued, it should to the extent possible embody a cost-benefit framework designed to minimize the sum of administrative (including litigation) and error costs. The nature of such a possible law, and the role the FTC might play in administering it, however, is a topic for another day.

The language of the federal antitrust laws is extremely general. Over more than a century, the federal courts have applied common-law techniques to construe this general language to provide guidance to the private sector as to what does or does not run afoul of the law. The interpretive process has been fraught with some uncertainty, as judicial approaches to antitrust analysis have changed several times over the past century. Nevertheless, until very recently, judges and enforcers had converged toward relying on a consumer welfare standard as the touchstone for antitrust evaluations (see my antitrust primer here, for an overview).

While imperfect and subject to potential error in application—a problem of legal interpretation generally—the consumer welfare principle has worked rather well as the focus both for antitrust-enforcement guidance and judicial decision-making. The general stability and predictability of antitrust under a consumer welfare framework has advanced the rule of law. It has given businesses sufficient information to plan transactions in a manner likely to avoid antitrust liability. It thereby has cabined uncertainty and increased the probability that private parties would enter welfare-enhancing commercial arrangements, to the benefit of society.

In a very thoughtful 2017 speech, then Acting Assistant Attorney General for Antitrust Andrew Finch commented on the importance of the rule of law to principled antitrust enforcement. He noted:

[H]ow do we administer the antitrust laws more rationally, accurately, expeditiously, and efficiently? … Law enforcement requires stability and continuity both in rules and in their application to specific cases.

Indeed, stability and continuity in enforcement are fundamental to the rule of law. The rule of law is about notice and reliance. When it is impossible to make reasonable predictions about how a law will be applied, or what the legal consequences of conduct will be, these important values are diminished. To call our antitrust regime a “rule of law” regime, we must enforce the law as written and as interpreted by the courts and advance change with careful thought.

The reliance fostered by stability and continuity has obvious economic benefits. Businesses invest, not only in innovation but in facilities, marketing, and personnel, and they do so based on the economic and legal environment they expect to face.

Of course, we want businesses to make those investments—and shape their overall conduct—in accordance with the antitrust laws. But to do so, they need to be able to rely on future application of those laws being largely consistent with their expectations. An antitrust enforcement regime with frequent changes is one that businesses cannot plan for, or one that they will plan for by avoiding certain kinds of investments.

That is certainly not to say there has not been positive change in the antitrust laws in the past, or that we would have been better off without those changes. U.S. antitrust law has been refined, and occasionally recalibrated, with the courts playing their appropriate interpretive role. And enforcers must always be on the watch for new or evolving threats to competition.  As markets evolve and products develop over time, our analysis adapts. But as those changes occur, we pursue reliability and consistency in application in the antitrust laws as much as possible.

Indeed, we have enjoyed remarkable continuity and consensus for many years. Antitrust law in the U.S. has not been a “paradox” for quite some time, but rather a stable and valuable law enforcement regime with appropriately widespread support.

Unfortunately, policy decisions taken by the new Federal Trade Commission (FTC) leadership in recent weeks have rejected antitrust continuity and consensus. They have injected substantial uncertainty into the application of competition-law enforcement by the FTC. This abrupt change in emphasis undermines the rule of law and threatens to reduce economic welfare.

As of now, the FTC’s departure from the rule of law has been notable in two areas:

  1. Its rejection of previous guidance on the agency’s “unfair methods of competition” authority, the FTC’s primary non-merger-related enforcement tool; and
  2. Its new advice rejecting time limits for the review of generally routine proposed mergers.

In addition, potential FTC rulemakings directed at “unfair methods of competition” would, if pursued, prove highly problematic.

Rescission of the Unfair Methods of Competition Policy Statement

The FTC on July 1 voted 3-2 to rescind the 2015 FTC Policy Statement Regarding Unfair Methods of Competition under Section 5 of the FTC Act (UMC Policy Statement).

The bipartisan UMC Policy Statement has originally been supported by all three Democratic commissioners, including then-Chairwoman Edith Ramirez. The policy statement generally respected and promoted the rule of law by emphasizing that, in applying the facially broad “unfair methods of competition” (UMC) language, the FTC would be guided by the well-established principles of the antitrust rule of reason (including considering any associated cognizable efficiencies and business justifications) and the consumer welfare standard. The FTC also explained that it would not apply “standalone” Section 5 theories to conduct that would violate the Sherman or Clayton Acts.

In short, the UMC Policy Statement sent a strong signal that the commission would apply UMC in a manner fully consistent with accepted and well-understood antitrust policy principles. As in the past, the vast bulk of FTC Section 5 prosecutions would be brought against conduct that violated the core antitrust laws. Standalone Section 5 cases would be directed solely at those few practices that harmed consumer welfare and competition, but somehow fell into a narrow crack in the basic antitrust statutes (such as, perhaps, “invitations to collude” that lack plausible efficiency justifications). Although the UMC Statement did not answer all questions regarding what specific practices would justify standalone UMC challenges, it substantially limited business uncertainty by bringing Section 5 within the boundaries of settled antitrust doctrine.

The FTC’s announcement of the UMC Policy Statement rescission unhelpfully proclaimed that “the time is right for the Commission to rethink its approach and to recommit to its mandate to police unfair methods of competition even if they are outside the ambit of the Sherman or Clayton Acts.” As a dissenting statement by Commissioner Christine S. Wilson warned, consumers would be harmed by the commission’s decision to prioritize other unnamed interests. And as Commissioner Noah Joshua Phillips stressed in his dissent, the end result would be reduced guidance and greater uncertainty.

In sum, by suddenly leaving private parties in the dark as to how to conform themselves to Section 5’s UMC requirements, the FTC’s rescission offends the rule of law.

New Guidance to Parties Considering Mergers

For decades, parties proposing mergers that are subject to statutory Hart-Scott-Rodino (HSR) Act pre-merger notification requirements have operated under the understanding that:

  1. The FTC and U.S. Justice Department (DOJ) will routinely grant “early termination” of review (before the end of the initial 30-day statutory review period) to those transactions posing no plausible competitive threat; and
  2. An enforcement agency’s decision not to request more detailed documents (“second requests”) after an initial 30-day pre-merger review effectively serves as an antitrust “green light” for the proposed acquisition to proceed.

Those understandings, though not statutorily mandated, have significantly reduced antitrust uncertainty and related costs in the planning of routine merger transactions. The rule of law has been advanced through an effective assurance that business combinations that appear presumptively lawful will not be the target of future government legal harassment. This has advanced efficiency in government, as well; it is a cost-beneficial optimal use of resources for DOJ and the FTC to focus exclusively on those proposed mergers that present a substantial potential threat to consumer welfare.

Two recent FTC pronouncements (one in tandem with DOJ), however, have generated great uncertainty by disavowing (at least temporarily) those two welfare-promoting review policies. Joined by DOJ, the FTC on Feb. 4 announced that the agencies would temporarily suspend early terminations, citing an “unprecedented volume of filings” and a transition to new leadership. More than six months later, this “temporary” suspension remains in effect.

Citing “capacity constraints” and a “tidal wave of merger filings,” the FTC subsequently published an Aug. 3 blog post that effectively abrogated the 30-day “green lighting” of mergers not subject to a second request. It announced that it was sending “warning letters” to firms reminding them that FTC investigations remain open after the initial 30-day period, and that “[c]ompanies that choose to proceed with transactions that have not been fully investigated are doing so at their own risk.”

The FTC’s actions interject unwarranted uncertainty into merger planning and undermine the rule of law. Preventing early termination on transactions that have been approved routinely not only imposes additional costs on business; it hints that some transactions might be subject to novel theories of liability that fall outside the antitrust consensus.

Perhaps more significantly, as three prominent antitrust practitioners point out, the FTC’s warning letters states that:

[T]he FTC may challenge deals that “threaten to reduce competition and harm consumers, workers, and honest businesses.” Adding in harm to both “workers and honest businesses” implies that the FTC may be considering more ways that transactions can have an adverse impact other than just harm to competition and consumers [citation omitted].

Because consensus antitrust merger analysis centers on consumer welfare, not the protection of labor or business interests, any suggestion that the FTC may be extending its reach to these new areas is inconsistent with established legal principles and generates new business-planning risks.

More generally, the Aug. 6 FTC “blog post could be viewed as an attempt to modify the temporal framework of the HSR Act”—in effect, an effort to displace an implicit statutory understanding in favor of an agency diktat, contrary to the rule of law. Commissioner Wilson sees the blog post as a means to keep investigations open indefinitely and, thus, an attack on the decades-old HSR framework for handling most merger reviews in an expeditious fashion (see here). Commissioner Phillips is concerned about an attempt to chill legal M&A transactions across the board, particularly unfortunate when there is no reason to conclude that particular transactions are illegal (see here).

Finally, the historical record raises serious questions about the “resource constraint” justification for the FTC’s new merger review policies:

Through the end of July 2021, more than 2,900 transactions were reported to the FTC. It is not clear, however, whether these record-breaking HSR filing numbers have led (or will lead) to more deals being investigated. Historically, only about 13 percent of all deals reported are investigated in some fashion, and roughly 3 percent of all deals reported receive a more thorough, substantive review through the issuance of a Second Request. Even if more deals are being reported, for the majority of transactions, the HSR process is purely administrative, raising no antitrust concerns, and, theoretically, uses few, if any, agency resources. [Citations omitted.]

Proposed FTC Competition Rulemakings

The new FTC leadership is strongly considering competition rulemakings. As I explained in a recent Truth on the Market post, such rulemakings would fail a cost-benefit test. They raise serious legal risks for the commission and could impose wasted resource costs on the FTC and on private parties. More significantly, they would raise two very serious economic policy concerns:

First, competition rules would generate higher error costs than adjudications. Adjudications cabin error costs by allowing for case-specific analysis of likely competitive harms and procompetitive benefits. In contrast, competition rules inherently would be overbroad and would suffer from a very high rate of false positives. By characterizing certain practices as inherently anticompetitive without allowing for consideration of case-specific facts bearing on actual competitive effects, findings of rule violations inevitably would condemn some (perhaps many) efficient arrangements.

Second, competition rules would undermine the rule of law and thereby reduce economic welfare. FTC-only competition rules could lead to disparate legal treatment of a firm’s business practices, depending upon whether the FTC or the U.S. Justice Department was the investigating agency. Also, economic efficiency gains could be lost due to the chilling of aggressive efficiency-seeking business arrangements in those sectors subject to rules. [Emphasis added.]

In short, common law antitrust adjudication, focused on the consumer welfare standard, has done a good job of promoting a vibrant competitive economy in an efficient fashion. FTC competition rulemaking would not.

Conclusion

Recent FTC actions have undermined consensus antitrust-enforcement standards and have departed from established merger-review procedures with respect to seemingly uncontroversial consolidations. Those decisions have imposed costly uncertainty on the business sector and are thereby likely to disincentivize efficiency-seeking arrangements. What’s more, by implicitly rejecting consensus antitrust principles, they denigrate the primacy of the rule of law in antitrust enforcement. The FTC’s pursuit of competition rulemaking would further damage the rule of law by imposing arbitrary strictures that ignore matter-specific considerations bearing on the justifications for particular business decisions.

Fortunately, these are early days in the Biden administration. The problematic initial policy decisions delineated in this comment could be reversed based on further reflection and deliberation within the commission. Chairwoman Lina Khan and her fellow Democratic commissioners would benefit by consulting more closely with Commissioners Wilson and Phillips to reach agreement on substantive and procedural enforcement policies that are better tailored to promote consumer welfare and enhance vibrant competition. Such policies would benefit the U.S. economy in a manner consistent with the rule of law.

The Biden Administration’s July 9 Executive Order on Promoting Competition in the American Economy is very much a mixed bag—some positive aspects, but many negative ones.

It will have some positive effects on economic welfare, to the extent it succeeds in lifting artificial barriers to competition that harm consumers and workers—such as allowing direct sales of hearing aids in drug stores—and helping to eliminate unnecessary occupational licensing restrictions, to name just two of several examples.

But it will likely have substantial negative effects on economic welfare as well. Many aspects of the order appear to emphasize new regulation—such as Net Neutrality requirements that may reduce investment in broadband by internet service providers—and imposing new regulatory requirements on airlines, pharmaceutical companies, digital platforms, banks, railways, shipping, and meat packers, among others. Arbitrarily imposing new rules in these areas, without a cost-beneficial appraisal and a showing of a market failure, threatens to reduce innovation and slow economic growth, hurting producers and consumer. (A careful review of specific regulatory proposals may shed greater light on the justifications for particular regulations.)

Antitrust-related proposals to challenge previously cleared mergers, and to impose new antitrust rulemaking, are likely to raise costly business uncertainty, to the detriment of businesses and consumers. They are a recipe for slower economic growth, not for vibrant competition.

An underlying problem with the order is that it is based on the false premise that competition has diminished significantly in recent decades and that “big is bad.” Economic analysis found in the February 2020 Economic Report of the President, and in other economic studies, debunks this flawed assumption.

In short, the order commits the fundamental mistake of proposing intrusive regulatory solutions for a largely nonexistent problem. Competitive issues are best handled through traditional well-accepted antitrust analysis, which centers on promoting consumer welfare and on weighing procompetitive efficiencies against anticompetitive harm on a case-by-case basis. This approach:

  1. Deals effectively with serious competitive problems; while at the same time
  2. Cabining error costs by taking into account all economically relevant considerations on a case-specific basis.

Rather than using an executive order to direct very specific regulatory approaches without a strong economic and factual basis, the Biden administration would have been better served by raising a host of competitive issues that merit possible study and investigation by expert agencies. Such an approach would have avoided imposing the costs of unwarranted regulation that unfortunately are likely to stem from the new order.

Finally, the order’s call for new regulations and the elimination of various existing legal policies will spawn matter-specific legal challenges, and may, in many cases, not succeed in court. This will impose unnecessary business uncertainty in addition to public and private resources wasted on litigation.

Advocates of legislative action to “reform” antitrust law have already pointed to the U.S. District Court for the District of Columbia’s dismissal of the state attorneys general’s case and the “conditional” dismissal of the Federal Trade Commission’s case against Facebook as evidence that federal antitrust case law is lax and demands correction. In fact, the court’s decisions support the opposite implication. 

The Risks of Antitrust by Anecdote

The failure of a well-resourced federal regulator, and more than 45 state attorney-general offices, to avoid dismissal at an early stage of the litigation testifies to the dangers posed by a conclusory approach toward antitrust enforcement that seeks to unravel acquisitions consummated almost a decade ago without even demonstrating the factual predicates to support consideration of such far-reaching interventions. The dangers to the rule of law are self-evident. Irrespective of one’s views on the appropriate direction of antitrust law, this shortcut approach would substitute prosecutorial fiat, ideological predilection, and popular sentiment for decades of case law and agency guidelines grounded in the rigorous consideration of potential evidence of competitive harm. 

The paucity of empirical support for the exceptional remedial action sought by the FTC is notable. As the district court observed, there was little systematic effort made to define the economically relevant market or provide objective evidence of market power, beyond the assertion that Facebook has a market share of “in excess of 60%.” Remarkably, the denominator behind that 60%-plus assertion is not precisely defined, since the FTC’s brief does not supply any clear metric by which to measure market share. As the court pointed out, this is a nontrivial task in multi-sided environments in which one side of the potentially relevant market delivers services to users at no charge.  

While the point may seem uncontroversial, it is important to re-appreciate why insisting on a rigorous demonstration of market power is critical to preserving a coherent body of law that provides the market with a basis for reasonably anticipating the likelihood of antitrust intervention. At least since the late 1970s, courts have recognized that “big is not always bad” and can often yield cost savings that ultimately redound to consumers’ benefit. That is: firm size and consumer welfare do not stand in inherent opposition. If courts were to abandon safeguards against suits that cannot sufficiently define the relevant market and plausibly show market power, antitrust litigation could easily be used as a tool to punish successful firms that prevail over competitors simply by being more efficient. In other words: antitrust law could become a tool to preserve competitor welfare at the expense of consumer welfare.

The Specter of No-Fault Antitrust Liability

The absence of any specific demonstration of market power suggests deficient lawyering or the inability to gather supporting evidence. Giving the FTC litigation team the benefit of the doubt, the latter becomes the stronger possibility. If that is the case, this implies an effort to persuade courts to adopt a de facto rule of per se illegality for any firm that achieves a certain market share. (The same concept lies behind legislative proposals to bar acquisitions for firms that cross a certain revenue or market capitalization threshold.) Effectively, any firm that reached a certain size would operate under the presumption that it has market power and has secured or maintained such power due to anticompetitive practices, rather than business prowess. This would effectively convert leading digital platforms into quasi-public utilities subject to continuous regulatory intervention. Such an approach runs counter to antitrust law’s mission to preserve, rather than displace, private ordering by market forces.  

Even at the high-water point of post-World War II antitrust zealotry (a period that ultimately ended in economic malaise), proposals to adopt a rule of no-fault liability for alleged monopolization were rejected. This was for good reason. Any such rule would likely injure consumers by precluding them from enjoying the cost savings that result from the “sweet spot” scenario in which the scale and scope economies of large firms are combined with sufficiently competitive conditions to yield reduced prices and increased convenience for consumers. Additionally, any such rule would eliminate incumbents’ incentives to work harder to offer consumers reduced prices and increased convenience, since any market share preserved or acquired as a result would simply invite antitrust scrutiny as a reward.

Remembering Why Market Power Matters

To be clear, this is not to say that “Big Tech” does not deserve close antitrust scrutiny, does not wield market power in certain segments, or has not potentially engaged in anticompetitive practices.  The fundamental point is that assertions of market power and anticompetitive conduct must be demonstrated, rather than being assumed or “proved” based largely on suggestive anecdotes.  

Perhaps market power will be shown sufficiently in Facebook’s case if the FTC elects to respond to the court’s invitation to resubmit its brief with a plausible definition of the relevant market and indication of market power at this stage of the litigation. If that threshold is satisfied, then thorough consideration of the allegedly anticompetitive effect of Facebook’s WhatsApp and Instagram acquisitions may be merited. However, given the policy interest in preserving the market’s confidence in relying on the merger-review process under the Hart-Scott-Rodino Act, the burden of proof on the government should be appropriately enhanced to reflect the significant time that has elapsed since regulatory decisions not to intervene in those transactions.  

It would once have seemed mundane to reiterate that market power must be reasonably demonstrated to support a monopolization claim that could lead to a major divestiture remedy. Given the populist thinking that now leads much of the legislative and regulatory discussion on antitrust policy, it is imperative to reiterate the rationale behind this elementary principle. 

This principle reflects the fact that, outside collusion scenarios, antitrust law is typically engaged in a complex exercise to balance the advantages of scale against the risks of anticompetitive conduct. At its best, antitrust law weighs competing facts in a good faith effort to assess the net competitive harm posed by a particular practice. While this exercise can be challenging in digital markets that naturally converge upon a handful of leading platforms or multi-dimensional markets that can have offsetting pro- and anti-competitive effects, these are not reasons to treat such an exercise as an anachronistic nuisance. Antitrust cases are inherently challenging and proposed reforms to make them easier to win are likely to endanger, rather than preserve, competitive markets.

There is little doubt that Federal Trade Commission (FTC) unfair methods of competition rulemaking proceedings are in the offing. Newly named FTC Chair Lina Khan and Commissioner Rohit Chopra both have extolled the benefits of competition rulemaking in a major law review article. What’s more, in May, Commissioner Rebecca Slaughter (during her stint as acting chair) established a rulemaking unit in the commission’s Office of General Counsel empowered to “explore new rulemakings to prohibit unfair or deceptive practices and unfair methods of competition” (emphasis added).

In short, a majority of sitting FTC commissioners apparently endorse competition rulemaking proceedings. As such, it is timely to ask whether FTC competition rules would promote consumer welfare, the paramount goal of competition policy.

In a recently published Mercatus Center research paper, I assess the case for competition rulemaking from a competition perspective and find it wanting. I conclude that, before proceeding, the FTC should carefully consider whether such rulemakings would be cost-beneficial. I explain that any cost-benefit appraisal should weigh both the legal risks and the potential economic policy concerns (error costs and “rule of law” harms). Based on these considerations, competition rulemaking is inappropriate. The FTC should stick with antitrust enforcement as its primary tool for strengthening the competitive process and thereby promoting consumer welfare.

A summary of my paper follows.

Section 6(g) of the original Federal Trade Commission Act authorizes the FTC “to make rules and regulations for the purpose of carrying out the provisions of this subchapter.” Section 6(g) rules are enacted pursuant to the “informal rulemaking” requirements of Section 553 of the Administrative Procedures Act (APA), which apply to the vast majority of federal agency rulemaking proceedings.

Before launching Section 6(g) competition rulemakings, however, the FTC would be well-advised first to weigh the legal risks and policy concerns associated with such an endeavor. Rulemakings are resource-intensive proceedings and should not lightly be undertaken without an eye to their feasibility and implications for FTC enforcement policy.

Only one appeals court decision addresses the scope of Section 6(g) rulemaking. In 1971, the FTC enacted a Section 6(g) rule stating that it was both an “unfair method of competition” and an “unfair act or practice” for refiners or others who sell to gasoline retailers “to fail to disclose clearly and conspicuously in a permanent manner on the pumps the minimum octane number or numbers of the motor gasoline being dispensed.” In 1973, in the National Petroleum Refiners case, the U.S. Court of Appeals for the D.C. Circuit upheld the FTC’s authority to promulgate this and other binding substantive rules. The court rejected the argument that Section 6(g) authorized only non-substantive regulations concerning regarding the FTC’s non-adjudicatory, investigative, and informative functions, spelled out elsewhere in Section 6.

In 1975, two years after National Petroleum Refiners was decided, Congress granted the FTC specific consumer-protection rulemaking authority (authorizing enactment of trade regulation rules dealing with unfair or deceptive acts or practices) through Section 202 of the Magnuson-Moss Warranty Act, which added Section 18 to the FTC Act. Magnuson-Moss rulemakings impose adjudicatory-type hearings and other specific requirements on the FTC, unlike more flexible section 6(g) APA informal rulemakings. However, the FTC can obtain civil penalties for violation of Magnuson-Moss rules, something it cannot do if 6(g) rules are violated.

In a recent set of public comments filed with the FTC, the Antitrust Section of the American Bar Association stated:

[T]he Commission’s [6(g)] rulemaking authority is buried in within an enumerated list of investigative powers, such as the power to require reports from corporations and partnerships, for example. Furthermore, the [FTC] Act fails to provide any sanctions for violating any rule adopted pursuant to Section 6(g). These two features strongly suggest that Congress did not intend to give the agency substantive rulemaking powers when it passed the Federal Trade Commission Act.

Rephrased, this argument suggests that the structure of the FTC Act indicates that the rulemaking referenced in Section 6(g) is best understood as an aid to FTC processes and investigations, not a source of substantive policymaking. Although the National Petroleum Refiners decision rejected such a reading, that ruling came at a time of significant judicial deference to federal agency activism, and may be dated.

The U.S. Supreme Court’s April 2021 decision in AMG Capital Management v. FTC further bolsters the “statutory structure” argument that Section 6(g) does not authorize substantive rulemaking. In AMG, the U.S. Supreme Court unanimously held that Section 13(b) of the FTC Act, which empowers the FTC to seek a “permanent injunction” to restrain an FTC Act violation, does not authorize the FTC to seek monetary relief from wrongdoers. The court’s opinion rejected the FTC’s argument that the term “permanent injunction” had historically been understood to include monetary relief. The court explained that the injunctive language was “buried” in a lengthy provision that focuses on injunctive, not monetary relief (note that the term “rules” is similarly “buried” within 6(g) language dealing with unrelated issues). The court also pointed to the structure of the FTC Act, with detailed and specific monetary-relief provisions found in Sections 5(l) and 19, as “confirm[ing] the conclusion” that Section 13(b) does not grant monetary relief.

By analogy, a court could point to Congress’ detailed enumeration of substantive rulemaking provisions in Section 18 (a mere two years after National Petroleum Refiners) as cutting against the claim that Section 6(g) can also be invoked to support substantive rulemaking. Finally, the Supreme Court in AMG flatly rejected several relatively recent appeals court decisions that upheld Section 13(b) monetary-relief authority. It follows that the FTC cannot confidently rely on judicial precedent (stemming from one arguably dated court decision, National Petroleum Refiners) to uphold its competition rulemaking authority.

In sum, the FTC will have to overcome serious fundamental legal challenges to its section 6(g) competition rulemaking authority if it seeks to promulgate competition rules.

Even if the FTC’s 6(g) authority is upheld, it faces three other types of litigation-related risks.

First, applying the nondelegation doctrine, courts might hold that the broad term “unfair methods of competition” does not provide the FTC “an intelligible principle” to guide the FTC’s exercise of discretion in rulemaking. Such a judicial holding would mean the FTC could not issue competition rules.

Second, a reviewing court might strike down individual proposed rules as “arbitrary and capricious” if, say, the court found that the FTC rulemaking record did not sufficiently take into account potentially procompetitive manifestations of a condemned practice.

Third, even if a final competition rule passes initial legal muster, applying its terms to individual businesses charged with rule violations may prove difficult. Individual businesses may seek to structure their conduct to evade the particular strictures of a rule, and changes in commercial practices may render less common the specific acts targeted by a rule’s language.

Economic Policy Concerns Raised by Competition Rulemaking

In addition to legal risks, any cost-benefit appraisal of FTC competition rulemaking should consider the economic policy concerns raised by competition rulemaking. These fall into two broad categories.

First, competition rules would generate higher error costs than adjudications. Adjudications cabin error costs by allowing for case-specific analysis of likely competitive harms and procompetitive benefits. In contrast, competition rules inherently would be overbroad and would suffer from a very high rate of false positives. By characterizing certain practices as inherently anticompetitive without allowing for consideration of case-specific facts bearing on actual competitive effects, findings of rule violations inevitably would condemn some (perhaps many) efficient arrangements.

Second, competition rules would undermine the rule of law and thereby reduce economic welfare. FTC-only competition rules could lead to disparate legal treatment of a firm’s business practices, depending upon whether the FTC or the U.S. Justice Department was the investigating agency. Also, economic efficiency gains could be lost due to the chilling of aggressive efficiency-seeking business arrangements in those sectors subject to rules.

Conclusion

A combination of legal risks and economic policy harms strongly counsels against the FTC’s promulgation of substantive competition rules.

First, litigation issues would consume FTC resources and add to the costly delays inherent in developing competition rules in the first place. The compounding of separate serious litigation risks suggests a significant probability that costs would be incurred in support of rules that ultimately would fail to be applied.

Second, even assuming competition rules were to be upheld, their application would raise serious economic policy questions. The inherent inflexibility of rule-based norms is ill-suited to deal with dynamic evolving market conditions, compared with matter-specific antitrust litigation that flexibly applies the latest economic thinking to particular circumstances. New competition rules would also exacerbate costly policy inconsistencies stemming from the existence of dual federal antitrust enforcement agencies, the FTC and the Justice Department.

In conclusion, an evaluation of rule-related legal risks and economic policy concerns demonstrates that a reallocation of some FTC enforcement resources to the development of competition rules would not be cost-effective. Continued sole reliance on case-by-case antitrust litigation would generate greater economic welfare than a mixture of litigation and competition rules.

Politico has released a cache of confidential Federal Trade Commission (FTC) documents in connection with a series of articles on the commission’s antitrust probe into Google Search a decade ago. The headline of the first piece in the series argues the FTC “fumbled the future” by failing to follow through on staff recommendations to pursue antitrust intervention against the company. 

But while the leaked documents shed interesting light on the inner workings of the FTC, they do very little to substantiate the case that the FTC dropped the ball when the commissioners voted unanimously not to bring an action against Google.

Drawn primarily from memos by the FTC’s lawyers, the Politico report purports to uncover key revelations that undermine the FTC’s decision not to sue Google. None of the revelations, however, provide evidence that Google’s behavior actually harmed consumers.

The report’s overriding claim—and the one most consistently forwarded by antitrust activists on Twitter—is that FTC commissioners wrongly sided with the agency’s economists (who cautioned against intervention) rather than its lawyers (who tenuously recommended very limited intervention). 

Indeed, the overarching narrative is that the lawyers knew what was coming and the economists took wildly inaccurate positions that turned out to be completely off the mark:

But the FTC’s economists successfully argued against suing the company, and the agency’s staff experts made a series of predictions that would fail to match where the online world was headed:

— They saw only “limited potential for growth” in ads that track users across the web — now the backbone of Google parent company Alphabet’s $182.5 billion in annual revenue.

— They expected consumers to continue relying mainly on computers to search for information. Today, about 62 percent of those queries take place on mobile phones and tablets, nearly all of which use Google’s search engine as the default.

— They thought rivals like Microsoft, Mozilla or Amazon would offer viable competition to Google in the market for the software that runs smartphones. Instead, nearly all U.S. smartphones run on Google’s Android and Apple’s iOS.

— They underestimated Google’s market share, a heft that gave it power over advertisers as well as companies like Yelp and Tripadvisor that rely on search results for traffic.

The report thus asserts that:

The agency ultimately voted against taking action, saying changes Google made to its search algorithm gave consumers better results and therefore didn’t unfairly harm competitors.

That conclusion underplays what the FTC’s staff found during the probe. In 312 pages of documents, the vast majority never publicly released, staffers outlined evidence that Google had taken numerous steps to ensure it would continue to dominate the market — including emerging arenas such as mobile search and targeted advertising. [EMPHASIS ADDED]

What really emerges from the leaked memos, however, is analysis by both the FTC’s lawyers and economists infused with a healthy dose of humility. There were strong political incentives to bring a case. As one of us noted upon the FTC’s closing of the investigation: “It’s hard to imagine an agency under more pressure, from more quarters (including the Hill), to bring a case around search.” Yet FTC staff and commissioners resisted that pressure, because prediction is hard. 

Ironically, the very prediction errors that the agency’s staff cautioned against are now being held against them. Yet the claims that these errors (especially the economists’) systematically cut in one direction (i.e., against enforcement) and that all of their predictions were wrong are both wide of the mark. 

Decisions Under Uncertainty

In seeking to make an example out of the FTC economists’ inaccurate predictions, critics ignore that antitrust investigations in dynamic markets always involve a tremendous amount of uncertainty; false predictions are the norm. Accordingly, the key challenge for policymakers is not so much to predict correctly, but to minimize the impact of incorrect predictions.

Seen in this light, the FTC economists’ memo is far from the laissez-faire manifesto that critics make it out to be. Instead, it shows agency officials wrestling with uncertain market outcomes, and choosing a course of action under the assumption the predictions they make might indeed be wrong. 

Consider the following passage from FTC economist Ken Heyer’s memo:

The great American philosopher Yogi Berra once famously remarked “Predicting is difficult, especially about the future.” How right he was. And yet predicting, and making decisions based on those predictions, is what we are charged with doing. Ignoring the potential problem is not an option. So I will be reasonably clear about my own tentative conclusions and recommendation, recognizing that reasonable people, perhaps applying a somewhat different standard, may disagree. My recommendation derives from my read of the available evidence, combined with the standard I personally find appropriate to apply to Commission intervention. [EMPHASIS ADDED]

In other words, contrary to what many critics have claimed, it simply is not the case that the FTC’s economists based their recommendations on bullish predictions about the future that ultimately failed to transpire. Instead, they merely recognized that, in a dynamic and unpredictable environment, antitrust intervention requires both a clear-cut theory of anticompetitive harm and a reasonable probability that remedies can improve consumer welfare. According to the economists, those conditions were absent with respect to Google Search.

Perhaps more importantly, it is worth asking why the economists’ erroneous predictions matter at all. Do critics believe that developments the economists missed warrant a different normative stance today?

In that respect, it is worth noting that the economists’ skepticism appeared to have rested first and foremost on the speculative nature of the harms alleged and the difficulty associated with designing appropriate remedies. And yet, if anything, these two concerns appear even more salient today. 

Indeed, the remedies imposed against Google in the EU have not delivered the outcomes that enforcers expected (here and here). This could either be because the remedies were insufficient or because Google’s market position was not due to anticompetitive conduct. Similarly, there is still no convincing economic theory or empirical research to support the notion that exclusive pre-installation and self-preferencing by incumbents harm consumers, and a great deal of reason to think they benefit them (see, e.g., our discussions of the issue here and here). 

Against this backdrop, criticism of the FTC economists appears to be driven more by a prior assumption that intervention is necessary—and that it was and is disingenuous to think otherwise—than evidence that erroneous predictions materially affected the outcome of the proceedings.

To take one example, the fact that ad tracking grew faster than the FTC economists believed it would is no less consistent with vigorous competition—and Google providing a superior product—than with anticompetitive conduct on Google’s part. The same applies to the growth of mobile operating systems. Ditto the fact that no rival has managed to dislodge Google in its most important markets. 

In short, not only were the economist memos informed by the very prediction difficulties that critics are now pointing to, but critics have not shown that any of the staff’s (inevitably) faulty predictions warranted a different normative outcome.

Putting Erroneous Predictions in Context

So what were these faulty predictions, and how important were they? Politico asserts that “the FTC’s economists successfully argued against suing the company, and the agency’s staff experts made a series of predictions that would fail to match where the online world was headed,” tying this to the FTC’s failure to intervene against Google over “tactics that European regulators and the U.S. Justice Department would later label antitrust violations.” The clear message is that the current actions are presumptively valid, and that the FTC’s economists thwarted earlier intervention based on faulty analysis.

But it is far from clear that these faulty predictions would have justified taking a tougher stance against Google. One key question for antitrust authorities is whether they can be reasonably certain that more efficient competitors will be unable to dislodge an incumbent. This assessment is necessarily forward-looking. Framed this way, greater market uncertainty (for instance, because policymakers are dealing with dynamic markets) usually cuts against antitrust intervention.

This does not entirely absolve the FTC economists who made the faulty predictions. But it does suggest the right question is not whether the economists made mistakes, but whether virtually everyone did so. The latter would be evidence of uncertainty, and thus weigh against antitrust intervention.

In that respect, it is worth noting that the staff who recommended that the FTC intervene also misjudged the future of digital markets.For example, while Politico surmises that the FTC “underestimated Google’s market share, a heft that gave it power over advertisers as well as companies like Yelp and Tripadvisor that rely on search results for traffic,” there is a case to be made that the FTC overestimated this power. If anything, Google’s continued growth has opened new niches in the online advertising space.

Pinterest provides a fitting example; despite relying heavily on Google for traffic, its ad-funded service has witnessed significant growth. The same is true of other vertical search engines like Airbnb, Booking.com, and Zillow. While we cannot know the counterfactual, the vertical search industry has certainly not been decimated by Google’s “monopoly”; quite the opposite. Unsurprisingly, this has coincided with a significant decrease in the cost of online advertising, and the growth of online advertising relative to other forms.

Politico asserts not only that the economists’ market share and market power calculations were wrong, but that the lawyers knew better:

The economists, relying on data from the market analytics firm Comscore, found that Google had only limited impact. They estimated that between 10 and 20 percent of traffic to those types of sites generally came from the search engine.

FTC attorneys, though, used numbers provided by Yelp and found that 92 percent of users visited local review sites from Google. For shopping sites like eBay and TheFind, the referral rate from Google was between 67 and 73 percent.

This compares apples and oranges, or maybe oranges and grapefruit. The economists’ data, from Comscore, applied to vertical search overall. They explicitly noted that shares for particular sites could be much higher or lower: for comparison shopping, for example, “ranging from 56% to less than 10%.” This, of course, highlights a problem with the data provided by Yelp, et al.: it concerns only the websites of companies complaining about Google, not the overall flow of traffic for vertical search.

But the more important point is that none of the data discussed in the memos represents the overall flow of traffic for vertical search. Take Yelp, for example. According to the lawyers’ memo, 92 percent of Yelp searches were referred from Google. Only, that’s not true. We know it’s not true because, as Yelp CEO Jerry Stoppelman pointed out around this time in Yelp’s 2012 Q2 earnings call: 

When you consider that 40% of our searches come from mobile apps, there is quite a bit of un-monetized mobile traffic that we expect to unlock in the near future.

The numbers being analyzed by the FTC staff were apparently limited to referrals to Yelp’s website from browsers. But is there any reason to think that is the relevant market, or the relevant measure of customer access? Certainly there is nothing in the staff memos to suggest they considered the full scope of the market very carefully here. Indeed, the footnote in the lawyers’ memo presenting the traffic data is offered in support of this claim:

Vertical websites, such as comparison shopping and local websites, are heavily dependent on Google’s web search results to reach users. Thus, Google is in the unique position of being able to “make or break any web-based business.”

It’s plausible that vertical search traffic is “heavily dependent” on Google Search, but the numbers offered in support of that simply ignore the (then) 40 percent of traffic that Yelp acquired through its own mobile app, with no Google involvement at all. In any case, it is also notable that, while there are still somewhat fewer app users than web users (although the number has consistently increased), Yelp’s app users view significantly more pages than its website users do — 10 times as many in 2015, for example.

Also noteworthy is that, for whatever speculative harm Google might be able to visit on the company, at the time of the FTC’s analysis Yelp’s local ad revenue was consistently increasing — by 89% in Q3 2012. And that was without any ad revenue coming from its app (display ads arrived on Yelp’s mobile app in Q1 2013, a few months after the staff memos were written and just after the FTC closed its Google Search investigation). 

In short, the search-engine industry is extremely dynamic and unpredictable. Contrary to what many have surmised from the FTC staff memo leaks, this cuts against antitrust intervention, not in favor of it.

The FTC Lawyers’ Weak Case for Prosecuting Google

At the same time, although not discussed by Politico, the lawyers’ memo also contains errors, suggesting that arguments for intervention were also (inevitably) subject to erroneous prediction.

Among other things, the FTC attorneys’ memo argued the large upfront investments were required to develop cutting-edge algorithms, and that these effectively shielded Google from competition. The memo cites the following as a barrier to entry:

A search engine requires algorithmic technology that enables it to search the Internet, retrieve and organize information, index billions of regularly changing web pages, and return relevant results instantaneously that satisfy the consumer’s inquiry. Developing such algorithms requires highly specialized personnel with high levels of training and knowledge in engineering, economics, mathematics, sciences, and statistical analysis.

If there are barriers to entry in the search-engine industry, algorithms do not seem to be the source. While their market shares may be smaller than Google’s, rival search engines like DuckDuckGo and Bing have been able to enter and gain traction; it is difficult to say that algorithmic technology has proven a barrier to entry. It may be hard to do well, but it certainly has not proved an impediment to new firms entering and developing workable and successful products. Indeed, some extremely successful companies have entered into similar advertising markets on the backs of complex algorithms, notably Instagram, Snapchat, and TikTok. All of these compete with Google for advertising dollars.

The FTC’s legal staff also failed to see that Google would face serious competition in the rapidly growing voice assistant market. In other words, even its search-engine “moat” is far less impregnable than it might at first appear.

Moreover, as Ben Thompson argues in his Stratechery newsletter: 

The Staff memo is completely wrong too, at least in terms of the potential for their proposed remedies to lead to any real change in today’s market. This gets back to why the fundamental premise of the Politico article, along with much of the antitrust chatter in Washington, misses the point: Google is dominant because consumers like it.

This difficulty was deftly highlighted by Heyer’s memo:

If the perceived problems here can be solved only through a draconian remedy of this sort, or perhaps through a remedy that eliminates Google’s legitimately obtained market power (and thus its ability to “do evil”), I believe the remedy would be disproportionate to the violation and that its costs would likely exceed its benefits. Conversely, if a remedy well short of this seems likely to prove ineffective, a remedy would be undesirable for that reason. In brief, I do not see a feasible remedy for the vertical conduct that would be both appropriate and effective, and which would not also be very costly to implement and to police. [EMPHASIS ADDED]

Of course, we now know that this turned out to be a huge issue with the EU’s competition cases against Google. The remedies in both the EU’s Google Shopping and Android decisions were severely criticized by rival firms and consumer-defense organizations (here and here), but were ultimately upheld, in part because even the European Commission likely saw more forceful alternatives as disproportionate.

And in the few places where the legal staff concluded that Google’s conduct may have caused harm, there is good reason to think that their analysis was flawed.

Google’s ‘revenue-sharing’ agreements

It should be noted that neither the lawyers nor the economists at the FTC were particularly bullish on bringing suit against Google. In most areas of the investigation, neither recommended that the commission pursue a case. But one of the most interesting revelations from the recent leaks is that FTC lawyers did advise the commission’s leadership to sue Google over revenue-sharing agreements that called for it to pay Apple and other carriers and manufacturers to pre-install its search bar on mobile devices:

FTC staff urged the agency’s five commissioners to sue Google for signing exclusive contracts with Apple and the major wireless carriers that made sure the company’s search engine came pre-installed on smartphones.

The lawyers’ stance is surprising, and, despite actions subsequently brought by the EU and DOJ on similar claims, a difficult one to countenance. 

To a first approximation, this behavior is precisely what antitrust law seeks to promote: we want companies to compete aggressively to attract consumers. This conclusion is in no way altered when competition is “for the market” (in this case, firms bidding for exclusive placement of their search engines) rather than “in the market” (i.e., equally placed search engines competing for eyeballs).

Competition for exclusive placement has several important benefits. For a start, revenue-sharing agreements effectively subsidize consumers’ mobile device purchases. As Brian Albrecht aptly puts it:

This payment from Google means that Apple can lower its price to better compete for consumers. This is standard; some of the payment from Google to Apple will be passed through to consumers in the form of lower prices.

This finding is not new. For instance, Ronald Coase famously argued that the Federal Communications Commission (FCC) was wrong to ban the broadcasting industry’s equivalent of revenue-sharing agreements, so-called payola:

[I]f the playing of a record by a radio station increases the sales of that record, it is both natural and desirable that there should be a charge for this. If this is not done by the station and payola is not allowed, it is inevitable that more resources will be employed in the production and distribution of records, without any gain to consumers, with the result that the real income of the community will tend to decline. In addition, the prohibition of payola may result in worse record programs, will tend to lessen competition, and will involve additional expenditures for regulation. The gain which the ban is thought to bring is to make the purchasing decisions of record buyers more efficient by eliminating “deception.” It seems improbable to me that this problematical gain will offset the undoubted losses which flow from the ban on Payola.

Applying this logic to Google Search, it is clear that a ban on revenue-sharing agreements would merely lead both Google and its competitors to attract consumers via alternative means. For Google, this might involve “complete” vertical integration into the mobile phone market, rather than the open-licensing model that underpins the Android ecosystem. Valuable specialization may be lost in the process.

Moreover, from Apple’s standpoint, Google’s revenue-sharing agreements are profitable only to the extent that consumers actually like Google’s products. If it turns out they don’t, Google’s payments to Apple may be outweighed by lower iPhone sales. It is thus unlikely that these agreements significantly undermined users’ experience. To the contrary, Apple’s testimony before the European Commission suggests that “exclusive” placement of Google’s search engine was mostly driven by consumer preferences (as the FTC economists’ memo points out):

Apple would not offer simultaneous installation of competing search or mapping applications. Apple’s focus is offering its customers the best products out of the box while allowing them to make choices after purchase. In many countries, Google offers the best product or service … Apple believes that offering additional search boxes on its web browsing software would confuse users and detract from Safari’s aesthetic. Too many choices lead to consumer confusion and greatly affect the ‘out of the box’ experience of Apple products.

Similarly, Kevin Murphy and Benjamin Klein have shown that exclusive contracts intensify competition for distribution. In other words, absent theories of platform envelopment that are arguably inapplicable here, competition for exclusive placement would lead competing search engines to up their bids, ultimately lowering the price of mobile devices for consumers.

Indeed, this revenue-sharing model was likely essential to spur the development of Android in the first place. Without this prominent placement of Google Search on Android devices (notably thanks to revenue-sharing agreements with original equipment manufacturers), Google would likely have been unable to monetize the investment it made in the open source—and thus freely distributed—Android operating system. 

In short, Politico and the FTC legal staff do little to show that Google’s revenue-sharing payments excluded rivals that were, in fact, as efficient. In other words, Bing and Yahoo’s failure to gain traction may simply be the result of inferior products and cost structures. Critics thus fail to show that Google’s behavior harmed consumers, which is the touchstone of antitrust enforcement.

Self-preferencing

Another finding critics claim as important is that FTC leadership declined to bring suit against Google for preferencing its own vertical search services (this information had already been partially leaked by the Wall Street Journal in 2015). Politico’s framing implies this was a mistake:

When Google adopted one algorithm change in 2011, rival sites saw significant drops in traffic. Amazon told the FTC that it saw a 35 percent drop in traffic from the comparison-shopping sites that used to send it customers

The focus on this claim is somewhat surprising. Even the leaked FTC legal staff memo found this theory of harm had little chance of standing up in court:

Staff has investigated whether Google has unlawfully preferenced its own content over that of rivals, while simultaneously demoting rival websites…. 

…Although it is a close call, we do not recommend that the Commission proceed on this cause of action because the case law is not favorable to our theory, which is premised on anticompetitive product design, and in any event, Google’s efficiency justifications are strong. Most importantly, Google can legitimately claim that at least part of the conduct at issue improves its product and benefits users. [EMPHASIS ADDED]

More importantly, as one of us has argued elsewhere, the underlying problem lies not with Google, but with a standard asset-specificity trap:

A content provider that makes itself dependent upon another company for distribution (or vice versa, of course) takes a significant risk. Although it may benefit from greater access to users, it places itself at the mercy of the other — or at least faces great difficulty (and great cost) adapting to unanticipated, crucial changes in distribution over which it has no control…. 

…It was entirely predictable, and should have been expected, that Google’s algorithm would evolve. It was also entirely predictable that it would evolve in ways that could diminish or even tank Foundem’s traffic. As one online marketing/SEO expert puts it: On average, Google makes about 500 algorithm changes per year. 500!….

…In the absence of an explicit agreement, should Google be required to make decisions that protect a dependent company’s “asset-specific” investments, thus encouraging others to take the same, excessive risk? 

Even if consumers happily visited rival websites when they were higher-ranked and traffic subsequently plummeted when Google updated its algorithm, that drop in traffic does not amount to evidence of misconduct. To hold otherwise would be to grant these rivals a virtual entitlement to the state of affairs that exists at any given point in time. 

Indeed, there is good reason to believe Google’s decision to favor its own content over that of other sites is procompetitive. Beyond determining and ensuring relevance, Google surely has the prerogative to compete vigorously and decide how to design its products to keep up with a changing market. In this case, that means designing, developing, and offering its own content in ways that partially displace the original “ten blue links” design of its search results page and instead offer its own answers to users’ queries.

Competitor Harm Is Not an Indicator of the Need for Intervention

Some of the other information revealed by the leak is even more tangential, such as that the FTC ignored complaints from Google’s rivals:

Amazon and Facebook privately complained to the FTC about Google’s conduct, saying their business suffered because of the company’s search bias, scraping of content from rival sites and restrictions on advertisers’ use of competing search engines. 

Amazon said it was so concerned about the prospect of Google monopolizing the search advertising business that it willingly sacrificed revenue by making ad deals aimed at keeping Microsoft’s Bing and Yahoo’s search engine afloat.

But complaints from rivals are at least as likely to stem from vigorous competition as from anticompetitive exclusion. This goes to a core principle of antitrust enforcement: antitrust law seeks to protect competition and consumer welfare, not rivals. Competition will always lead to winners and losers. Antitrust law protects this process and (at least theoretically) ensures that rivals cannot manipulate enforcers to safeguard their economic rents. 

This explains why Frank Easterbrook—in his seminal work on “The Limits of Antitrust”—argued that enforcers should be highly suspicious of complaints lodged by rivals:

Antitrust litigation is attractive as a method of raising rivals’ costs because of the asymmetrical structure of incentives…. 

…One line worth drawing is between suits by rivals and suits by consumers. Business rivals have an interest in higher prices, while consumers seek lower prices. Business rivals seek to raise the costs of production, while consumers have the opposite interest…. 

…They [antitrust enforcers] therefore should treat suits by horizontal competitors with the utmost suspicion. They should dismiss outright some categories of litigation between rivals and subject all such suits to additional scrutiny.

Google’s competitors spent millions pressuring the FTC to bring a case against the company. But why should it be a failing for the FTC to resist such pressure? Indeed, as then-commissioner Tom Rosch admonished in an interview following the closing of the case:

They [Google’s competitors] can darn well bring [a case] as a private antitrust action if they think their ox is being gored instead of free-riding on the government to achieve the same result.

Not that they would likely win such a case. Google’s introduction of specialized shopping results (via the Google Shopping box) likely enabled several retailers to bypass the Amazon platform, thus increasing competition in the retail industry. Although this may have temporarily reduced Amazon’s traffic and revenue (Amazon’s sales have grown dramatically since then), it is exactly the outcome that antitrust laws are designed to protect.

Conclusion

When all is said and done, Politico’s revelations provide a rarely glimpsed look into the complex dynamics within the FTC, which many wrongly imagine to be a monolithic agency. Put simply, the FTC’s commissioners, lawyers, and economists often disagree vehemently about the appropriate course of conduct. This is a good thing. As in many other walks of life, having a market for ideas is a sure way to foster sound decision making.

But in the final analysis, what the revelations do not show is that the FTC’s market for ideas failed consumers a decade ago when it declined to bring an antitrust suit against Google. They thus do little to cement the case for antitrust intervention—whether a decade ago, or today.

A pending case in the U.S. Court of Appeals for the 3rd Circuit has raised several interesting questions about the FTC enforcement approach and patent litigation in the pharmaceutical industry.  The case, FTC v. AbbVie, involves allegations that AbbVie (and Besins) filed sham patent infringement cases against generic manufacturer Teva (and Perrigo) for the purpose of preventing or delaying entry into the testosterone gel market in which AbbVie’s AndroGel had a monopoly.  The FTC further alleges that AbbVie and Teva settled the testosterone gel litigation in AbbVie’s favor while making a large payment to Teva in an unrelated case, behavior that, considered together, amounted to an illegal reverse payment settlement. The district court dismissed the reverse payment claims, but concluded that the patent infringement cases were sham litigation. It ordered disgorgement damages of $448 million against AbbVie and Besins which was the profit they gained from maintaining the AndroGel monopoly.

The 3rd Circuit has been asked to review several elements of the district court’s decision including whether the original patent infringement cases amounted to sham litigation, whether the payment to Teva in a separate case amounted to an illegal reverse payment, and whether the FTC has the authority to seek disgorgement damages.  The decision will help to clarify outstanding issues relating to patent litigation and the FTC’s enforcement abilities, but it also has the potential to chill pro-competitive behavior in the pharmaceutical market encouraged under Hatch-Waxman. 

First, the 3rd Circuit will review whether AbbVie’s patent infringement case was sham litigation by asking whether the district court applied the right standard and how plaintiffs must prove that lawsuits are baseless.  The district court determined that the case was a sham because it was objectively baseless (AbbVie couldn’t reasonably expect to win) and subjectively baseless (AbbVie brought the cases solely to delay generic entry into the market).  AbbVie argues that the district court erred by not requiring affirmative evidence of bad faith and not requiring the FTC to present clear and convincing evidence that AbbVie and its attorneys believed the lawsuits were baseless.

While sham litigation should be penalized and deterred, especially when it produces anticompetitive effects, the 3rd Circuit’s decision, depending on how it comes out, also has the potential to deter brand drug makers from filing patent infringement cases in the first place.  This threatens to disrupt the delicate balance that Hatch-Waxman sought to establish between protecting generic entry while encouraging brand competition.

The 3rd Circuit will also determine whether AbbVie’s payment to Teva in a separate case involving cholesterol medicine was an illegal reverse payment, otherwise known as a “pay-for-delay” settlement.  The FTC asserts that the actions in the two cases—one involving testosterone gel and the other involving cholesterol medicine—should be considered together, but the district court disagreed and determined there was no illegal reverse payment.  True pay-for-delay settlements are anticompetitive and harm consumers by delaying their access to cheaper generic alternatives.  However, an overly-liberal definition of what constitutes an illegal reverse payment will deter legitimate settlements, thereby increasing expenses for all parties that choose to litigate and possibly dissuading generics from bringing patent challenges in the first place.  Moreover, FTC’s argument that two settlements occurring in separate cases around the same time is suspicious overlooks the reality that the pharmaceutical industry has become increasingly concentrated and drug companies often have more than one pending litigation matter against another company involving entirely different products and circumstances. 

Finally, the 3rd Circuit will determine whether the FTC has the authority to seek disgorgement damages on past acts like settled patent litigation.  AbbVie has argued that the agency has no right to disgorgement because it isn’t enumerated in the FTC Act and because courts can’t order injunctive relieve, including disgorgement, on completed past acts. 

The FTC has sought disgorgement damages only sparingly, but the frequency with which the agency seeks disgorgement and the amount of the damages have increased in recent years. Proponents of the FTC’s approach argue that the threat of large disgorgement damages provides a strong deterrent to anticompetitive behavior.  While true, FTC-ordered disgorgement (even if permissible) may go too far and end up chilling economic activity by exposing businesses to exorbitant liability without clear guidance on when disgorgement will be awarded. The 3rd Circuit will determine whether the FTC’s enforcement approach is authorized, a decision that has important implications for whether the agency’s enforcement can deter unfair practices without depressing economic activity.

I posted this originally on my own blog, but decided to cross-post here since Thom and I have been blogging on this topic.

“The U.S. stock market is having another solid year. You wouldn’t know it by looking at the shares of companies that manage money.”

That’s the lead from Charles Stein on Bloomberg’s Markets’ page today. Stein goes on to offer three possible explanations: 1) a weary bull market, 2) a move toward more active stock-picking by individual investors, and 3) increasing pressure on fees.

So what has any of that to do with the common ownership issue? A few things.

First, it shows that large institutional investors must not be very good at harvesting the benefits of the non-competitive behavior they encourage among the firms the invest in–if you believe they actually do that in the first place. In other words, if you believe common ownership is a problem because CEOs are enriching institutional investors by softening competition, you must admit they’re doing a pretty lousy job of capturing that value.

Second, and more importantly–as well as more relevant–the pressure on fees has led money managers to emphasis low-cost passive index funds. Indeed, among the firms doing well according to the article is BlackRock, “whose iShares exchange-traded fund business tracks indexes, won $20 billion.” In an aggressive move, Fidelity has introduced a total of four zero-fee index funds as a way to draw fee-conscious investors. These index tracking funds are exactly the type of inter-industry diversified funds that negate any incentive for competition softening in any one industry.

Finally, this also illustrates the cost to the investing public of the limits on common ownership proposed by the likes of Einer Elhague, Eric Posner, and Glen Weyl. Were these types of proposals in place, investment managers could not offer diversified index funds that include more than one firm’s stock from any industry with even a moderate level of market concentration. Given competitive forces are pushing investment companies to increase the offerings of such low-cost index funds, any regulatory proposal that precludes those possibilities is sure to harm the investing public.

Just one more piece of real evidence that common ownership is not only not a problem, but that the proposed “fixes” are.

On November 1st and 2nd, Cofece, the Mexican Competition Agency, hosted an International Competition Network (ICN) workshop on competition advocacy, featuring presentations from government agency officials, think tanks, and international organizations.  The workshop highlighted the excellent work that the ICN has done in supporting efforts to curb the most serious source of harm to the competitive process worldwide:  government enactment of anticompetitive regulatory schemes and guidance, often at the behest of well-connected, cronyist rent-seeking businesses that seek to protect their privileges by imposing costs on rivals.

The ICN describes the goal of its Advocacy Working Group in the following terms:

The mission of the Advocacy Working Group (AWG) is to undertake projects, to develop practical tools and guidance, and to facilitate experience-sharing among ICN member agencies, in order to improve the effectiveness of ICN members in advocating the dissemination of competition principles and to promote the development of a competition culture within society. Advocacy reinforces the value of competition by educating citizens, businesses and policy-makers. In addition to supporting the efforts of competition agencies in tackling private anti-competitive behaviour, advocacy is an important tool in addressing public restrictions to competition. Competition advocacy in this context refers to those activities conducted by the competition agency, that are related to the promotion of a competitive environment by means of non-enforcement mechanisms, mainly through its relationships with other governmental entities and by increasing public awareness in regard to the benefits of competition.  

At the Cofece workshop, I moderated a panel on “stakeholder engagement in the advocacy process,” featuring presentations by representatives of Cofece, the Japan Fair Trade Commission, and the Organization for Economic Cooperation and Development.  As I emphasized in my panel presentation:

Developing an appropriate competition advocacy strategy is key to successful interventions.  Public officials should be mindful of the relative importance of particular advocacy targets, as well as matter-specific political constraints and competing stakeholder interests.  In particular, a competition authority may greatly benefit by identifying and motivating stakeholders who are directly affected by the competitive restraints that are targeted by advocacy interventions.  The active support of such stakeholders may be key to the success of an advocacy initiative.  More generally, by reaching out to business and consumer stakeholders, a competition authority may build alliances that will strengthen its long-term ability to be effective in promoting a pro-competition agenda. 

The U.S. Federal Trade Commission, the FTC, has developed a well-thought-out approach to building strong relationships with stakeholders.  The FTC holds public publicized workshops highlighting emerging policy issues, in which NGAs and civil society representatives with expertise are invited to participate.  Its personnel (and, in particular, its head) speak before a variety of audiences to inform them of what the FTC is doing and of the opportunities for advocacy filings.  It reaches out to civil society groups and the general public through the media, utilizing the Internet and other sources of public information dissemination.  It is willing to hold informal non-public meetings with NGAs and civil society representatives to hear their candid views and concerns off the record.  It carries out major studies (often following up on information gathered at workshops and from non-government sources) in addition to making advocacy filings.  It interacts closely with substantive FTC enforcers and economists to obtain “leads” that may inform future advocacy projects and to suggest possible lines for substantive investigations, based on the input it has received.  It communicates with other competition authorities on advocacy strategies.  Other competition authorities may wish to note the FTC’s approach in organizing their own advocacy programs.  

Competition authorities would also benefit from consulting the ICN Market Studies Good Practice Handbook, last released in updated form at the April 2016 ICN 15th Annual Conference.  This discussion of the role of stakeholders, though presented in the context of market studies, provides insights that are broadly applicable more generally to the competition advocacy process.  As the Handbook explains, stakeholders are any individuals, groups of individuals, or organizations that have an interest in a particular market or that can be affected by market conditions.  The Handbook explains the crucial inputs that stakeholders can provide a competition authority and how engaging with stakeholders can influence the authority’s reputation.  The Handbook emphasizes that a stakeholder engagement strategy can be used to determine whether particular stakeholders will be influential, supportive, or unsupportive to a particular endeavor; to consider the input expected from the various stakeholders and plan for soliciting and using this input; and to describing how and when the authority will seek to engage stakeholders.  The Handbook provides a long list of categories of stakeholders and suggests ways of reaching out to stakeholders, including through public consultations, open seminars, workshops, and roundtables.  Next, the Handbook presents tactics for engaging with stakeholders.  The Handbook closes by summarizing key good practices, including publicly soliciting broad voluntary stakeholder engagement, developing a stakeholder engagement strategy early in a particular process, and reviewing and updating the engagement strategy as necessary throughout a particular competition authority undertaking.

In sum, properly conducted advocacy initiatives, along with investigations of hard core cartels, are among the highest-valued uses of limited competition agency resources.  To the extent advocacy succeeds in unraveling government-imposed impediments to effective competition, it pays long-run dividends in terms of enhanced consumer welfare, greater economic efficiency, and more robust economic growth.  Let us hope that governments around the world (including, of course, the United States Government) keep this in mind in making resource commitments and setting priorities for their competition agencies.

Earlier this week I testified before the U.S. House Subcommittee on Commerce, Manufacturing, and Trade regarding several proposed FTC reform bills.

You can find my written testimony here. That testimony was drawn from a 100 page report, authored by Berin Szoka and me, entitled “The Federal Trade Commission: Restoring Congressional Oversight of the Second National Legislature — An Analysis of Proposed Legislation.” In the report we assess 9 of the 17 proposed reform bills in great detail, and offer a host of suggested amendments or additional reform proposals that, we believe, would help make the FTC more accountable to the courts. As I discuss in my oral remarks, that judicial oversight was part of the original plan for the Commission, and an essential part of ensuring that its immense discretion is effectively directed toward protecting consumers as technology and society evolve around it.

The report is “Report 2.0” of the FTC: Technology & Reform Project, which was convened by the International Center for Law & Economics and TechFreedom with an inaugural conference in 2013. Report 1.0 lays out some background on the FTC and its institutional dynamics, identifies the areas of possible reform at the agency, and suggests the key questions/issues each of them raises.

The text of my oral remarks follow, or, if you prefer, you can watch them here:

Chairman Burgess, Ranking Member Schakowsky, and Members of the Subcommittee, thank you for the opportunity to appear before you today.

I’m Executive Director of the International Center for Law & Economics, a non-profit, non-partisan research center. I’m a former law professor, I used to work at Microsoft, and I had what a colleague once called the most illustrious FTC career ever — because, at approximately 2 weeks, it was probably the shortest.

I’m not typically one to advocate active engagement by Congress in anything (no offense). But the FTC is different.

Despite Congressional reforms, the FTC remains the closest thing we have to a second national legislature. Its jurisdiction covers nearly every company in America. Section 5, at its heart, runs just 20 words — leaving the Commission enormous discretion to make policy decisions that are essentially legislative.

The courts were supposed to keep the agency on course. But they haven’t. As Former Chairman Muris has written, “the agency has… traditionally been beyond judicial control.”

So it’s up to Congress to monitor the FTC’s processes, and tweak them when the FTC goes off course, which is inevitable.

This isn’t a condemnation of the FTC’s dedicated staff. Rather, this one way ratchet of ever-expanding discretion is simply the nature of the beast.

Yet too many people lionize the status quo. They see any effort to change the agency from the outside as an affront. It’s as if Congress was struck by a bolt of lightning in 1914 and the Perfect Platonic Agency sprang forth.

But in the real world, an agency with massive scope and discretion needs oversight — and feedback on how its legal doctrines evolve.

So why don’t the courts play that role? Companies essentially always settle with the FTC because of its exceptionally broad investigatory powers, its relatively weak standard for voting out complaints, and the fact that those decisions effectively aren’t reviewable in federal court.

Then there’s the fact that the FTC sits in judgment of its own prosecutions. So even if a company doesn’t settle and actually wins before the ALJ, FTC staff still wins 100% of the time before the full Commission.

Able though FTC staffers are, this can’t be from sheer skill alone.

Whether by design or by neglect, the FTC has become, as Chairman Muris again described it, “a largely unconstrained agency.”

Please understand: I say this out of love. To paraphrase Churchill, the FTC is the “worst form of regulatory agency — except for all the others.”

Eventually Congress had to course-correct the agency — to fix the disconnect and to apply its own pressure to refocus Section 5 doctrine.

So a heavily Democratic Congress pressured the Commission to adopt the Unfairness Policy Statement in 1980. The FTC promised to restrain itself by balancing the perceived benefits of its unfairness actions against the costs, and not acting when injury is insignificant or consumers could have reasonably avoided injury on their own. It is, inherently, an economic calculus.

But while the Commission pays lip service to the test, you’d be hard-pressed to identify how (or whether) it’s implemented it in practice. Meanwhile, the agency has essentially nullified the “materiality” requirement that it volunteered in its 1983 Deception Policy Statement.

Worst of all, Congress failed to anticipate that the FTC would resume exercising its vast discretion through what it now proudly calls its “common law of consent decrees” in data security cases.

Combined with a flurry of recommended best practices in reports that function as quasi-rulemakings, these settlements have enabled the FTC to circumvent both Congressional rulemaking reforms and meaningful oversight by the courts.

The FTC’s data security settlements aren’t an evolving common law. They’re a static statement of “reasonable” practices, repeated about 55 times over the past 14 years. At this point, it’s reasonable to assume that they apply to all circumstances — much like a rule (which is, more or less, the opposite of the common law).

Congressman Pompeo’s SHIELD Act would help curtail this practice, especially if amended to include consent orders and reports. It would also help focus the Commission on the actual elements of the Unfairness Policy Statement — which should be codified through Congressman Mullins’ SURE Act.

Significantly, only one data security case has actually come before an Article III court. The FTC trumpets Wyndham as an out-and-out win. But it wasn’t. In fact, the court agreed with Wyndham on the crucial point that prior consent orders were of little use in trying to understand the requirements of Section 5.

More recently the FTC suffered another rebuke. While it won its product design suit against Amazon, the Court rejected the Commission’s “fencing in” request to permanently hover over the company and micromanage practices that Amazon had already ended.

As the FTC grapples with such cutting-edge legal issues, it’s drifting away from the balance it promised Congress.

But Congress can’t fix these problems simply by telling the FTC to take its bedrock policy statements more seriously. Instead it must regularly reassess the process that’s allowed the FTC to avoid meaningful judicial scrutiny. The FTC requires significant course correction if its model is to move closer to a true “common law.”

by Thomas W. Hazlett, H.H. Macaulay Endowed Chair in Economics at Clemson University

Josh Wright is a tour de force. He has broken the mold for a Washington regulator — and created a new one. As a scholar, he carefully crafts his analyses of public policy. As a strategic thinker, he tackles the issues that redound to the greatest social benefit. And as a champion of competitive markets, he forcefully advances rules to encourage innovation and consumer welfare. Nearly as important as his diligence within the regulatory process, he is transparent in his objectives and takes every opportunity to enunciate his principles for action. The public knows what he is doing and why it is important. 

As a sample of Commissioner Wright’s dedication to improving regulatory law, I am delighted to suggest the talk he gave April 2, 2015 at Clemson University, hosted by the Information Economy Project. His title: Regulation in High-Tech Markets: Public Choice, Regulatory Capture, and the FTC. He was particularly concerned in describing the harm produced by state and local barriers blocking competitive forces with respect to emerging, disruptive innovations such as Uber and AirBnB, offering remedies available via competition policy. The talk is posted here.

In its February 25 North Carolina Dental decision, the U.S. Supreme Court, per Justice Anthony Kennedy, held that a state regulatory board that is controlled by market participants in the industry being regulated cannot invoke “state action” antitrust immunity unless it is “actively supervised” by the state.  In so ruling, the Court struck a significant blow against protectionist rent-seeking and for economic liberty.  (As I stated in a recent Heritage Foundation legal memorandum, “[a] Supreme Court decision accepting this [active supervision] principle might help to curb special-interest favoritism conferred through state law.  At the very least, it could complicate the efforts of special interests to protect themselves from competition through regulation.”)

A North Carolina law subjects the licensing of dentistry to a North Carolina State Board of Dental Examiners (Board), six of whose eight members must be licensed dentists.  After dentists complained to the Board that non-dentists were charging lower prices than dentists for teeth whitening, the Board sent cease-and-desist letter to non-dentist teeth whitening providers, warning that the unlicensed practice dentistry is a crime.  This led non-dentists to cease teeth whitening services in North Carolina.  The Federal Trade Commission (FTC) held that the Board’s actions violated Section 5 of the FTC Act, which prohibits unfair methods of competition, the Fourth Circuit agreed, and the Court affirmed the Fourth Circuit’s decision.

In its decision, the Court rejected the claim that state action immunity, which confers immunity on the anticompetitive conduct of states acting in their sovereign capacity, applied to the Board’s actions.  The Court stressed that where a state delegates control over a market to a non-sovereign actor, immunity applies only if the state accepts political accountability by actively supervising that actor’s decisions.  The Court applied its Midcal test, which requires (1) clear state articulation and (2) active state supervision of decisions by non-sovereign actors for immunity to attach.  The Court held that entities designated as state agencies are not exempt from active supervision when they are controlled by market participants, because allowing an exemption in such circumstances would pose the risk of self-dealing that the second prong of Midcal was created to address.

Here, the Board did not contend that the state exercised any (let alone active) supervision over its anticompetitive conduct.  The Court closed by summarizing “a few constant requirements of active supervision,” namely, (1) the supervisor must review the substance of the anticompetitive decision, (2) the supervisor must have the power to veto or modify particular decisions for consistency with state policy, (3) “the mere potential for state supervision is not an adequate substitute for a decision by the State,” and (4) “the state supervisor may not itself be an active market participant.”  The Court cautioned, however, that “the adequacy of supervision otherwise will depend on all the circumstances of a case.”

Justice Samuel Alito, joined by Justices Antonin Scalia and Clarence Thomas, dissented, arguing that the Court ignored precedent that state agencies created by the state legislature (“[t]he Board is not a private or ‘nonsovereign’ entity”) are shielded by the state action doctrine.  “By straying from this simple path” and assessing instead whether individual agencies are subject to regulatory capture, the Court spawned confusion, according to the dissenters.  Midcal was inapposite, because it involved a private trade association.  The dissenters feared that the majority’s decision may require states “to change the composition of medical, dental, and other boards, but it is not clear what sort of changes are needed to satisfy the test that the Court now adopts.”  The dissenters concluded “that determining when regulatory capture has occurred is no simple task.  That answer provides a reason for relieving courts from the obligation to make such determinations at all.  It does not explain why it is appropriate for the Court to adopt the rather crude test for capture that constitutes the holding of today’s decision.”

The Court’s holding in North Carolina Dental helpfully limits the scope of the Court’s infamous Parker v. Brown decision (which shielded from federal antitrust attack a California raisin producers’ cartel overseen by a state body), without excessively interfering in sovereign state prerogatives.  State legislatures may still choose to create self-interested professional regulatory bodies – their sovereignty is not compromised.  Now, however, they will have to (1) make it clearer up front that they intend to allow those bodies to displace competition, and (2) subject those bodies to disinterested third party review.  These changes should make it far easier for competition advocates (including competition agencies) to spot and publicize welfare-inimical regulatory schemes, and weaken the incentive and ability of rent-seekers to undermine competition through state regulatory processes.  All told, the burden these new judicially-imposed constraints will impose on the states appears relatively modest, and should be far outweighed by the substantial welfare benefits they are likely to generate.