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Over the weekend, Senator Al Franken and FCC Commissioner Mignon Clyburn issued an impassioned statement calling for the FCC to thwart the use of mandatory arbitration clauses in ISPs’ consumer service agreements — starting with a ban on mandatory arbitration of privacy claims in the Chairman’s proposed privacy rules. Unfortunately, their call to arms rests upon a number of inaccurate or weak claims. Before the Commissioners vote on the proposed privacy rules later this week, they should carefully consider whether consumers would actually be served by such a ban.

FCC regulations can’t override congressional policy favoring arbitration

To begin with, it is firmly cemented in Supreme Court precedent that the Federal Arbitration Act (FAA) “establishes ‘a liberal federal policy favoring arbitration agreements.’” As the Court recently held:

[The FAA] reflects the overarching principle that arbitration is a matter of contract…. [C]ourts must “rigorously enforce” arbitration agreements according to their terms…. That holds true for claims that allege a violation of a federal statute, unless the FAA’s mandate has been “overridden by a contrary congressional command.”

For better or for worse, that’s where the law stands, and it is the exclusive province of Congress — not the FCC — to change it. Yet nothing in the Communications Act (to say nothing of the privacy provisions in Section 222 of the Act) constitutes a “contrary congressional command.”

And perhaps that’s for good reason. In enacting the statute, Congress didn’t demonstrate the same pervasive hostility toward companies and their relationships with consumers that has characterized the way this FCC has chosen to enforce the Act. As Commissioner O’Rielly noted in dissenting from the privacy NPRM:

I was also alarmed to see the Commission acting on issues that should be completely outside the scope of this proceeding and its jurisdiction. For example, the Commission seeks comment on prohibiting carriers from including mandatory arbitration clauses in contracts with their customers. Here again, the Commission assumes that consumers don’t understand the choices they are making and is willing to impose needless costs on companies by mandating how they do business.

If the FCC were to adopt a provision prohibiting arbitration clauses in its privacy rules, it would conflict with the FAA — and the FAA would win. Along the way, however, it would create a thorny uncertainty for both companies and consumers seeking to enforce their contracts.  

The evidence suggests that arbitration is pro-consumer

But the lack of legal authority isn’t the only problem with the effort to shoehorn an anti-arbitration bias into the Commission’s privacy rules: It’s also bad policy.

In its initial broadband privacy NPRM, the Commission said this about mandatory arbitration:

In the 2015 Open Internet Order, we agreed with the observation that “mandatory arbitration, in particular, may more frequently benefit the party with more resources and more understanding of the dispute procedure, and therefore should not be adopted.” We further discussed how arbitration can create an asymmetrical relationship between large corporations that are repeat players in the arbitration system and individual customers who have fewer resources and less experience. Just as customers should not be forced to agree to binding arbitration and surrender their right to their day in court in order to obtain broadband Internet access service, they should not have to do so in order to protect their private information conveyed through that service.

The Commission may have “agreed with the cited observations about arbitration, but that doesn’t make those views accurate. As one legal scholar has noted, summarizing the empirical data on the effects of arbitration:

[M]ost of the methodologically sound empirical research does not validate the criticisms of arbitration. To give just one example, [employment] arbitration generally produces higher win rates and higher awards for employees than litigation.

* * *

In sum, by most measures — raw win rates, comparative win rates, some comparative recoveries and some comparative recoveries relative to amounts claimed — arbitration generally produces better results for claimants [than does litigation].

A comprehensive, empirical study by Northwestern Law’s Searle Center on AAA (American Arbitration Association) cases found much the same thing, noting in particular that

  • Consumer claimants in arbitration incur average arbitration fees of only about $100 to arbitrate small (under $10,000) claims, and $200 for larger claims (up to $75,000).
  • Consumer claimants also win attorneys’ fees in over 60% of the cases in which they seek them.
  • On average, consumer arbitrations are resolved in under 7 months.
  • Consumers win some relief in more than 50% of cases they arbitrate…
  • And they do almost exactly as well in cases brought against “repeat-player” business.

In short, it’s extremely difficult to sustain arguments suggesting that arbitration is tilted against consumers relative to litigation.

(Upper) class actions: Benefitting attorneys — and very few others

But it isn’t just any litigation that Clyburn and Franken seek to preserve; rather, they are focused on class actions:

If you believe that you’ve been wronged, you could take your service provider to court. But you’d have to find a lawyer willing to take on a multi-national telecom provider over a few hundred bucks. And even if you won the case, you’d likely pay more in legal fees than you’d recover in the verdict.

The only feasible way for you as a customer to hold that corporation accountable would be to band together with other customers who had been similarly wronged, building a case substantial enough to be worth the cost—and to dissuade that big corporation from continuing to rip its customers off.

While — of course — litigation plays an important role in redressing consumer wrongs, class actions frequently don’t confer upon class members anything close to the imagined benefits that plaintiffs’ lawyers and their congressional enablers claim. According to a 2013 report on recent class actions by the law firm, Mayer Brown LLP, for example:

  • “In [the] entire data set, not one of the class actions ended in a final judgment on the merits for the plaintiffs. And none of the class actions went to trial, either before a judge or a jury.” (Emphasis in original).
  • “The vast majority of cases produced no benefits to most members of the putative class.”
  • “For those cases that do settle, there is often little or no benefit for class members. What is more, few class members ever even see those paltry benefits — particularly in consumer class actions.”
  • “The bottom line: The hard evidence shows that class actions do not provide class members with anything close to the benefits claimed by their proponents, although they can (and do) enrich attorneys.”

Similarly, a CFPB study of consumer finance arbitration and litigation between 2008 and 2012 seems to indicate that the class action settlements and judgments it studied resulted in anemic relief to class members, at best. The CFPB tries to disguise the results with large, aggregated and heavily caveated numbers (never once actually indicating what the average payouts per person were) that seem impressive. But in the only hard numbers it provides (concerning four classes that ended up settling in 2013), promised relief amounted to under $23 each (comprising both cash and in-kind payment) if every class member claimed against the award. Back-of-the-envelope calculations based on the rest of the data in the report suggest that result was typical.

Furthermore, the average time to settlement of the cases the CFPB looked at was almost 2 years. And somewhere between 24% and 37% involved a non-class settlement — meaning class members received absolutely nothing at all because the named plaintiff personally took a settlement.

By contrast, according to the Searle Center study, the average award in the consumer-initiated arbitrations it studied (admittedly, involving cases with a broader range of claims) was almost $20,000, and the average time to resolution was less than 7 months.

To be sure, class action litigation has been an important part of our system of justice. But, as Arthur Miller — a legal pioneer who helped author the rules that make class actions viable — himself acknowledged, they are hardly a panacea:

I believe that in the 50 years we have had this rule, that there are certain class actions that never should have been brought, admitted; that we have burdened our judiciary, yes. But we’ve had a lot of good stuff done. We really have.

The good that has been done, according to Professor Miller, relates in large part to the civil rights violations of the 50’s and 60’s, which the class action rules were designed to mitigate:

Dozens and dozens and dozens of communities were desegregated because of the class action. You even see desegregation decisions in my old town of Boston where they desegregated the school system. That was because of a class action.

It’s hard to see how Franken and Clyburn’s concern for redress of “a mysterious 99-cent fee… appearing on your broadband bill” really comes anywhere close to the civil rights violations that spawned the class action rules. Particularly given the increasingly pervasive role of the FCC, FTC, and other consumer protection agencies in addressing and deterring consumer harms (to say nothing of arbitration itself), it is manifestly unclear why costly, protracted litigation that infrequently benefits anyone other than trial attorneys should be deemed so essential.

“Empowering the 21st century [trial attorney]”

Nevertheless, Commissioner Clyburn and Senator Franken echo the privacy NPRM’s faulty concerns about arbitration clauses that restrict consumers’ ability to litigate in court:

If you’re prohibited from using our legal system to get justice when you’re wronged, what’s to protect you from being wronged in the first place?

Well, what do they think the FCC is — chopped liver?

Hardly. In fact, it’s a little surprising to see Commissioner Clyburn (who sits on a Commission that proudly proclaims that “[p]rotecting consumers is part of [its] DNA”) and Senator Franken (among Congress’ most vocal proponents of the FCC’s claimed consumer protection mission) asserting that the only protection for consumers from ISPs’ supposed depredations is the cumbersome litigation process.

In fact, of course, the FCC has claimed for itself the mantle of consumer protector, aimed at “Empowering the 21st Century Consumer.” But nowhere does the agency identify “promoting and preserving the rights of consumers to litigate” among its tools of consumer empowerment (nor should it). There is more than a bit of irony in a federal regulator — a commissioner of an agency charged with making sure, among other things, that corporations comply with the law — claiming that, without class actions, consumers are powerless in the face of bad corporate conduct.

Moreover, even if it were true (it’s not) that arbitration clauses tend to restrict redress of consumer complaints, effective consumer protection would still not necessarily be furthered by banning such clauses in the Commission’s new privacy rules.

The FCC’s contemplated privacy regulations are poised to introduce a wholly new and untested regulatory regime with (at best) uncertain consequences for consumers. Given the risk of consumer harm resulting from the imposition of this new regime, as well as the corollary risk of its excessive enforcement by complainants seeking to test or push the boundaries of new rules, an agency truly concerned with consumer protection would tread carefully. Perhaps, if the rules were enacted without an arbitration ban, it would turn out that companies would mandate arbitration (though this result is by no means certain, of course). And perhaps arbitration and agency enforcement alone would turn out to be insufficient to effectively enforce the rules. But given the very real costs to consumers of excessive, frivolous or potentially abusive litigation, cabining the litigation risk somewhat — even if at first it meant the regime were tilted slightly too much against enforcement — would be the sensible, cautious and pro-consumer place to start.

____

Whether rooted in a desire to “protect” consumers or not, the FCC’s adoption of a rule prohibiting mandatory arbitration clauses to address privacy complaints in ISP consumer service agreements would impermissibly contravene the FAA. As the Court has made clear, such a provision would “‘stand[] as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress’ embodied in the Federal Arbitration Act.” And not only would such a rule tend to clog the courts in contravention of the FAA’s objectives, it would do so without apparent benefit to consumers. Even if such a rule wouldn’t effectively be invalidated by the FAA, the Commission should firmly reject it anyway: A rule that operates primarily to enrich class action attorneys at the expense of their clients has no place in an agency charged with protecting the public interest.

The U.S. Supreme Court’s unanimous June 13 decision (per Chief Justice John Roberts) in Halo Electronics v. Pulse Electronics, overturning the Federal Circuit’s convoluted Seagate test for enhanced damages, is good news for patent holders.  By reducing the incentives for intentional patent infringement (due to the near impossibility of obtaining punitive damages relief under Seagate), Halo Electronics helps enhance the effectiveness of patent enforcement, thereby promoting a more robust patent system.

The complexity and unwieldiness of the Seagate test is readily apparent from this description:

35 U.S.C. § 284 provides simply that “the court may increase the damages up to three times the amount found or assessed.” Nevertheless, in In re Seagate Technology, LLC, 497 F.3d 1360 (2007) (en banc) the Federal Circuit erected a two-part barrier for patentees to clear before a district court could exercise its enhancement discretion under the statute. First, a patent owner must “show by clear and convincing evidence that the infringer acted despite an objectively high likelihood that its actions constituted an infringement of a valid patent.” This first part of the test is not met if the infringer, during infringement proceedings, raises a substantial question as to the validity or non-infringement of the patent, regardless of whether the infringer’s prior conduct was egregious. Second, the patentee must demonstrate that the risk of infringement “was either known or so obvious that it should have been known to the accused infringer.” On appeal, the Federal Circuit would review the first step of the test—objective recklessness—de novo; the second part—subjective knowledge—for substantial evidence; and the ultimate decision—whether to award enhanced damages—for abuse of discretion.

In short, under Seagate, even if (1) the patentee presented substantial evidence that the infringer intentionally infringed its patent (under the second part of the test), and (2) the infringer’s prior conduct was egregious, the infringer could avoid enhanced damages merely by raising a “substantial question” as to the validity or non-infringement of the patent.  Because in most cases mere “questions” as to validity or non-infringement could readily be ginned up ex post, intentional infringers, including truly “bad actors,” could largely ignore the risk of being assessed anything more than actual damages.

Moreover, the Seagate test should be viewed in light of other major policy changes that have diminished the value of patents, such as the near impossibility of obtaining permanent injunctive relief for patent infringement following the Supreme Court’s 2006 eBay decision (see, for example, here), plus the recent downward trend in patent damage awards (see, for example, here) and increasingly common administrative patent invalidations (see, for example, here).  All told, these developments have incentivized parties to “go ahead and produce,” without regard to the patents they might be infringing, in the knowledge that, at worst, they might at some future time be held liable for something akin to the reasonable royalties they should have agreed to pay in the first place.

Chief Justice Roberts’ opinion for the Court in Halo Electronics in effect reinstates the longstanding historical understandings that in patent infringement cases:  (1) district court judges enjoy broad discretion to assess enhanced damages “for egregious infringement behavior”; and (2) the standard “preponderance of the evidence” standard of civil litigation (rather than the far more exacting “clear and convincing evidence” standard of proof) applies to enhanced damages determinations.  In so doing, it puts potential infringers on notice that exemplary damages for egregious infringing actions cannot be avoided after the fact by manufactured theories (“questions”) of possible patent invalidity or non-applicability of a patent’s claims to the conduct in question.  This in turn should raise the expected costs of intentional patent infringement, thereby increasing the incentive for technology implementers to negotiate ex ante with patent holders over license terms.  To the extent this incentive change results in a higher incidence of licensing ex ante, a lower incidence of costly infringement litigation, and higher returns to patentees, economic welfare should tend to rise.

Halo Electronics’ “halo effect” should not, of course, be oversold.  The meaning of “egregious infringement behavior” will have to be hashed out in federal litigation, and it is unclear to what extent federal district courts may show a greater inclination to assess enhanced damages.   Furthermore, recent legislative and regulatory policy changes and uncertainties (including rising “anti-patent” sentiments in the Executive Branch, see, for example, here) continue to constrain incentives to patent, to the detriment of economic welfare.  Nevertheless, while perhaps less than “heavenly” in its impact, the Halo Electronics decision should have some effect in summoning up “the better angels of technology implementers’ nature” (paraphrasing Abraham Lincoln, a firm believer in a robust patent system) and causing them to better respect the property rights imbedded in the patented innovations on which they rely.

While we all wait on pins and needles for the DC Circuit to issue its long-expected ruling on the FCC’s Open Internet Order, another federal appeals court has pushed back on Tom Wheeler’s FCC for its unremitting “just trust us” approach to federal rulemaking.

The case, round three of Prometheus, et al. v. FCC, involves the FCC’s long-standing rules restricting common ownership of local broadcast stations and their extension by Tom Wheeler’s FCC to the use of joint sales agreements (JSAs). (For more background see our previous post here). Once again the FCC lost (it’s now only 1 for 3 in this case…), as the Third Circuit Court of Appeals took the Commission to task for failing to establish that its broadcast ownership rules were still in the public interest, as required by law, before it decided to extend those rules.

While much of the opinion deals with the FCC’s unreasonable delay (of more than 7 years) in completing two Quadrennial Reviews in relation to its diversity rules, the court also vacated the FCC’s rule expanding its duopoly rule (or local television ownership rule) to ban joint sales agreements without first undertaking the reviews.

We (the International Center for Law and Economics, along with affiliated scholars of law, economics, and communications) filed an amicus brief arguing for precisely this result, noting that

the 2014 Order [] dramatically expands its scope by amending the FCC’s local ownership attribution rules to make the rule applicable to JSAs, which had never before been subject to it. The Commission thereby suddenly declares unlawful JSAs in scores of local markets, many of which have been operating for a decade or longer without any harm to competition. Even more remarkably, it does so despite the fact that both the DOJ and the FCC itself had previously reviewed many of these JSAs and concluded that they were not likely to lessen competition. In doing so, the FCC also fails to examine the empirical evidence accumulated over the nearly two decades some of these JSAs have been operating. That evidence shows that many of these JSAs have substantially reduced the costs of operating TV stations and improved the quality of their programming without causing any harm to competition, thereby serving the public interest.

The Third Circuit agreed that the FCC utterly failed to justify its continued foray into banning potentially pro-competitive arrangements, finding that

the Commission violated § 202(h) by expanding the reach of the ownership rules without first justifying their preexisting scope through a Quadrennial Review. In Prometheus I we made clear that § 202(h) requires that “no matter what the Commission decides to do to any particular rule—retain, repeal, or modify (whether to make more or less stringent)—it must do so in the public interest and support its decision with a reasoned analysis.” Prometheus I, 373 F.3d at 395. Attribution of television JSAs modifies the Commission’s ownership rules by making them more stringent. And, unless the Commission determines that the preexisting ownership rules are sound, it cannot logically demonstrate that an expansion is in the public interest. Put differently, we cannot decide whether the Commission’s rationale—the need to avoid circumvention of ownership rules—makes sense without knowing whether those rules are in the public interest. If they are not, then the public interest might not be served by closing loopholes to rules that should no longer exist.

Perhaps this decision will be a harbinger of good things to come. The FCC — and especially Tom Wheeler’s FCC — has a history of failing to justify its rules with anything approaching rigorous analysis. The Open Internet Order is a case in point. We will all be better off if courts begin to hold the Commission’s feet to the fire and throw out their rules when the FCC fails to do the work needed to justify them.

Last March, I published an op ed in the the Washington Times on the proposed VENUE Act, a recently introduced bill taken wholesale from a portion of HR 9 (the tendentiously titled “Innovation Act”).  HR 9 has rightly stalled given its widespread and radical changes to the patent system that weaken and dilute all property rights in innovation.  Although superficially more “narrow” because the VENUE Act contains only the proposed venue rule changes in HR 9, the VENUE Act is just the Son of Frankenstein for the innovation industries.  This bill simply continues the anti-patent owner bias in the DC policy debates that has gone almost completely unchecked since before the start of President Obama’s first term in office.

Here’s a portion of my op ed:

The VENUE Act is the latest proposal in a multi-year campaign by certain companies and interest groups to revise the rules of the patent system. The fundamental problem is that this campaign has created an entirely one-sided narrative about patent “reform”: all the problems are caused by patent owners and thus the solutions require removing the incentives for patent owners to be bad actors in the innovation economy. This narrative is entirely biased against patented innovation, the driver of America’s innovation economy for over two hundred years that has recognized benefits. As a result, it has produced an equally biased policy debate that inexorably leads to the same conclusion in every “reform” proposal arising from this campaign: these vital property rights must be weakened, watered down, or eliminated when it comes to their licensing in the marketplace or enforcement in courts.

….

In this narrower bill to address litigation abuse, for instance, it is an Alice in Wonderland state of affairs to be talking only about stopping abuse of the courts by patent owners while blatantly ignoring the same abuse by challengers of patents in the administrative review programs run by the Patent Trial and Appeals Board (PTAB). It is widely recognized that the PTAB is incredibly biased against patents in both its procedural and substantive rules. The Supreme Court recently agreed to hear just one of many appeals that are currently working their way through the courts that explicitly address these concerns. There is legitimate outcry about hedge fund managers exploiting the PTAB’s bias against patents by filing petitions to invalidate patents after shorting stocks for bio-pharmaceutical companies that own these patents. The PTAB has been called a “death squad” for patents, and with a patent invalidation rate between 79% to 100%, this is not entirely unjustified rhetoric.

The absence of any acknowledgment that reform of the PTAB is just as pressingly important as venue reform by those pushing for the VENUE Act is a massive elephant in the room. Unfortunately, it is unsurprising. But this is only because it is the latest example of a strikingly one-sided, biased narrative of the past several years about patent “reform.”

As bloggers like to say: Read the whole thing here.

UPDATE: A more in-depth, legal analysis of proposed “venue reform” and the resulting collateral damage it imposes on all patent owners is provided by Devlin Hartline in his essay, “Changes to Patent Venue Rules Risk Collateral to Innovators,” which can be read here.

Yesterday a federal district court in Washington state granted the FTC’s motion for summary judgment against Amazon in FTC v. Amazon — the case alleging unfair trade practices in Amazon’s design of the in-app purchases interface for apps available in its mobile app store. The headlines score the decision as a loss for Amazon, and the FTC, of course, claims victory. But the court also granted Amazon’s motion for partial summary judgment on a significant aspect of the case, and the Commission’s win may be decidedly pyrrhic.

While the district court (very wrongly, in my view) essentially followed the FTC in deciding that a well-designed user experience doesn’t count as a consumer benefit for assessing substantial harm under the FTC Act, it rejected the Commission’s request for a permanent injunction against Amazon. It also called into question the FTC’s calculation of monetary damages. These last two may be huge. 

The FTC may have “won” the case, but it’s becoming increasingly apparent why it doesn’t want to take these cases to trial. First in Wyndham, and now in Amazon, courts have begun to chip away at the FTC’s expansive Section 5 discretion, even while handing the agency nominal victories.

The Good News

The FTC largely escapes judicial oversight in cases like these because its targets almost always settle (Amazon is a rare exception). These settlements — consent orders — typically impose detailed 20-year injunctions and give the FTC ongoing oversight of the companies’ conduct for the same period. The agency has wielded the threat of these consent orders as a powerful tool to micromanage tech companies, and it currently has at least one consent order in place with Twitter, Google, Apple, Facebook and several others.

As I wrote in a WSJ op-ed on these troubling consent orders:

The FTC prefers consent orders because they extend the commission’s authority with little judicial oversight, but they are too blunt an instrument for regulating a technology company. For the next 20 years, if the FTC decides that Google’s product design or billing practices don’t provide “express, informed consent,” the FTC could declare Google in violation of the new consent decree. The FTC could then impose huge penalties—tens or even hundreds of millions of dollars—without establishing that any consumer had actually been harmed.

Yesterday’s decision makes that outcome less likely. Companies will be much less willing to succumb to the FTC’s 20-year oversight demands if they know that courts may refuse the FTC’s injunction request and accept companies’ own, independent and market-driven efforts to address consumer concerns — without any special regulatory micromanagement.

In the same vein, while the court did find that Amazon was liable for repayment of unauthorized charges made without “express, informed authorization,” it also found the FTC’s monetary damages calculation questionable and asked for further briefing on the appropriate amount. If, as seems likely, it ultimately refuses to simply accept the FTC’s damages claims, that, too, will take some of the wind out of the FTC’s sails. Other companies have settled with the FTC and agreed to 20-year consent decrees in part, presumably, because of the threat of excessive damages if they litigate. That, too, is now less likely to happen.

Collectively, these holdings should help to force the FTC to better target its complaints to cases of still-ongoing and truly-harmful practices — the things the FTC Act was really meant to address, like actual fraud. Tech companies trying to navigate ever-changing competitive waters by carefully constructing their user interfaces and payment mechanisms (among other things) shouldn’t be treated the same way as fraudulent phishing scams.

The Bad News

The court’s other key holding is problematic, however. In essence, the court, like the FTC, seems to believe that regulators are better than companies’ product managers, designers and engineers at designing app-store user interfaces:

[A] clear and conspicuous disclaimer regarding in-app purchases and request for authorization on the front-end of a customer’s process could actually prove to… be more seamless than the somewhat unpredictable password prompt formulas rolled out by Amazon.

Never mind that Amazon has undoubtedly spent tremendous resources researching and designing the user experience in its app store. And never mind that — as Amazon is certainly aware — a consumer’s experience of a product is make-or-break in the cut-throat world of online commerce, advertising and search (just ask Jet).

Instead, for the court (and the FTC), the imagined mechanism of “affirmatively seeking a customer’s authorized consent to a charge” is all benefit and no cost. Whatever design decisions may have informed the way Amazon decided to seek consent are either irrelevant, or else the user-experience benefits they confer are negligible.

As I’ve written previously:

Amazon has built its entire business around the “1-click” concept — which consumers love — and implemented a host of notification and security processes hewing as much as possible to that design choice, but nevertheless taking account of the sorts of issues raised by in-app purchases. Moreover — and perhaps most significantly — it has implemented an innovative and comprehensive parental control regime (including the ability to turn off all in-app purchases) — Kindle Free Time — that arguably goes well beyond anything the FTC required in its Apple consent order.

Amazon is not abdicating its obligation to act fairly under the FTC Act and to ensure that users are protected from unauthorized charges. It’s just doing so in ways that also take account of the costs such protections may impose — particularly, in this case, on the majority of Amazon customers who didn’t and wouldn’t suffer such unauthorized charges.

Amazon began offering Kindle Free Time in 2012 as an innovative solution to a problem — children’s access to apps and in-app purchases — that affects only a small subset of Amazon’s customers. To dismiss that effort without considering that Amazon might have made a perfectly reasonable judgment that balanced consumer protection and product design disregards the cost-benefit balancing required by Section 5 of the FTC Act.

Moreover, the FTC Act imposes liability for harm only when they are not “reasonably avoidable.” Kindle Free Time is an outstanding example of an innovative mechanism that allows consumers at risk of unauthorized purchases by children to “reasonably avoid” harm. The court’s and the FTC’s disregard for it is inconsistent with the statute.

Conclusion

The court’s willingness to reinforce the FTC’s blackboard design “expertise” (such as it is) to second guess user-interface and other design decisions made by firms competing in real markets is unfortunate. But there’s a significant silver lining. By reining in the FTC’s discretion to go after these companies as if they were common fraudsters, the court has given consumers an important victory. After all, it is consumers who otherwise bear the costs (both directly and as a result of reduced risk-taking and innovation) of the FTC’s largely unchecked ability to extract excessive concessions from its enforcement targets.

By Morgan Reed

In Philip K. Dick’s famous short story that inspired the Total Recall movies, a company called REKAL could implant “extra-factual memories” into the minds of anyone. That technology may be fictional, but the Apple eBooks case suggests that the ability to insert extra-factual memories into the courts already exists.

The Department of Justice, the Second Circuit majority, and even the Solicitor General’s most recent filing opposing cert. all assert that the large publishing houses invented a new “agency” business model as a way to provide leverage to raise prices, and then pushed it on Apple.

The basis of the government’s claim is that Apple had “just two months to develop a business model” once Steve Jobs had approved the “iBookstore” ebook marketplace. The government implies that Apple was a company so obviously old, inept, and out-of-ideas that it had to rely on the big publishers for an innovative business model to help it enter the market. And the court bought it “wholesale,” as it were. (Describing Apple’s “a-ha” moment when it decided to try the agency model, the court notes, “[n]otably, the possibility of an agency arrangement was first mentioned by Hachette and HarperCollins as a way ‘to fix Amazon pricing.'”)

The claim has no basis in reality, of course. Apple had embraced the agency model long before, as it sought to disrupt the way software was distributed. In just the year prior, Apple had successfully launched the app store, a ground-breaking example of the agency model that started with only 500 apps but had grown to more than 100,000 in 12 months. This was an explosion of competition — remember, nearly all of those apps represented a new publisher: 100,000 new potential competitors.

So why would the government create such an absurd fiction?

Because without that fiction, Apple moves from “conspirator” to “competitor.” Instead of anticompetitive scourge, it becomes a disruptor, bringing new competition to an existing market with a single dominant player (Amazon Kindle), and shattering the control held by the existing publishing industry.

More than a decade before the App Store, software developers had observed that the wholesale model for distribution created tremendous barriers for entry, increased expense, and incredible delays in getting to market. Developers were beholden to a tiny number of physical stores that sold shelf space and required kickbacks (known as spiffs). Today, there are legions of developers producing App content, and developers have earned more than $10 billion in sales through Apple’s App Store. Anyone with an App idea or, moreover, an idea for a book, can take it straight to consumers rather than having to convince a publisher, wholesaler or retailer that it is worth purchasing and marketing.

This disintermediation is of critical benefit to consumers — and yet the Second Circuit missed it. The court chose instead to focus on the claim that if the horizontal competitors conspired, then Apple, which had approached the publishers to ensure initial content would exist at time of launch, was complicit. Somehow Apple could be a horizontal competitor even through it wasn’t part of the publishing industry!

There was another significant consumer and competitive benefit from Apple’s entry into the market and the shift to the agency model. Prior to the Apple iPad, truly interactive books were mostly science fiction, and the few pilot projects that existed had little consumer traction. Amazon, which held 90% of the electronic books market, chose to focus on creating technology that mirrored the characteristics of reading on paper: a black and white screen and the barest of annotation capabilities.

When the iPad was released, Apple sent up a signal flag that interactivity would be a focal point of the technology by rolling out tools that would allow developers to access the iPad’s accelerometer and touch sensitive screen to create an immersive experience. The result? Products that help children with learning disabilities, and competitors fighting back with improved products.

Finally, Apple’s impact on consumers and competition was profound. Amazon switched, as well, and the nascent world of self publishing exploded. Books like Hugh Howey’s Wool series (soon to be a major motion picture) were released as smaller chunks for only 99 cents. And “the Martian,” which is up for several Academy Awards found a home and an audience long before any major publisher came calling.

We all need to avoid the trip to REKAL and remember what life was like before the advent of the agency model. Because if the Second Circuit decision is allowed to stand, the implication for any outside competitor looking to disrupt a market is as grim and barren as the surface of Mars.

By Chris Sagers

United States v. Apple has fascinated me continually ever since the instantly-sensational complaint was made public, more than three years ago. Just one small, recent manifestation of the larger theme that makes it so interesting is the improbable range of folks who apparently consider certiorari rather likely—not least some commenters here, and even SCOTUSblog, which listed the case on their “Petitions We’re Watching.” It seems improbable, I say, not because reasonable people couldn’t differ on the policy issues. In this day and age somebody pops up to doubt every antitrust case brought against anybody no matter what. Rather, on the traditional criteria, the case just seems really ill-suited for cert.[*]

But it is in keeping with the larger story that people might expect the Court to take this basically hum-drum fact case in which there’s no circuit split. People have been savaging this case since its beginnings, despite the fact that to almost all antitrust lawyers it was such a legal slam dunk that so long as the government could prove its facts, it couldn’t lose.

And so I’m left with questions I’ve been asking since the case came out. Why, given the straightforward facts, nicely fitting a per se standard generally thought to be well-settled, involving conduct that on the elaborate trial record had no plausible effect except a substantial price increase,[**] do so many people hate this case? Why, more specifically, do so many people think there is something special about it, such that it shouldn’t be subject to the same rules that would apply to anybody else who did what these defendants did?

To be clear, I think the case is interesting. Big time. But what is interesting is not its facts or the underlying conduct or anything about book publishing or technological change or any of that. In other words, I don’t think the case is special. Like Jonathan Jacobson, I think it is simple.  What is remarkable is the reactions it has generated, across the political spectrum.

In the years of its pendency, on any number of panels and teleconferences and brown-bags and so on we’ve heard BigLaw corporate defense lawyers talking about the case like they’re Louis Brandeis. The problem, you see, is not a naked horizontal producer cartel coordinated by a retail entrant with a strong incentive to discipline its retail rival. No, no, no. The problem was actually Amazon, and the problem with Amazon was that it is big. Moreover, this case is about entry, they say, and entry is what antitrust is all about. Entry must be good, because numerosity in and of itself is competition. Consider too the number of BigLaw antitrust partners who’ve publicly argued that Amazon is in fact a monopolist, and that it engaged in predatory pricing, of all things.

When has anyone ever heard this group of people talk like that?

For another example, consider how nearly identical have been the views of left-wing critics like the New America Foundation’s Barry Lynn to those of the Second Circuit dissenter in Apple, the genteel, conservative Bush appointee, Judge Dennis Jacobs. They both claim, as essentially their only argument, that Amazon is a powerful firm, which can be tamed only if publishers can set their own retail prices (even if they do so collusively).

And there are so many other examples. The government’s case was condemned by no less than a Democrat and normally pro-enforcement member of the Senate antitrust committee, as it was by two papers as otherwise divergent as the Wall Street Journal and the New York Times. Meanwhile, the damnedest thing about the case, as I’ll show in a second, is that it frequently causes me to talk like Robert Bork.

So what the hell is going on?

I have a theory.  We in America have almost as our defining character, almost uniquely among developed nations, a commitment to markets, competition, and individual enterprise. But we tend to forget until a case like Apple reminds us that markets, when they work as they are supposed to, are machines for producing pain. Firms fail, people lose jobs, valuable institutions—like, perhaps, the paper book—are sometimes lost. And it can be hard to believe that such a free, decentralized mess will somehow magically optimize organization, distribution, and innovation. I think the reason people find a case like Apple hard to support is that, because we find all that loss and anarchy so hard to swallow, we as a people do not actually believe in competition at all.

I think it helps in making this point to work through the individual arguments that the Apple defendants and their supporters have made, in court and out. For my money, what we find is not only that most of the arguments are not really that strong, but that they are the same arguments that all defendants make, all the time. As it turns out, there has never been an antitrust defendant that didn’t think its market was special.

Taking the arguments I’ve heard, roughly in increasing order of plausibility:

  • Should it matter that discipline of Amazon’s aggressive pricing might help keep the publisher defendants in business? Hardly. While the lamentations of the publishers seem overblown—they may be forced to adapt, and it may not be painless, but that is much more likely at the moment than their insolvency—if they are forced out because they cannot compete on a price basis, then that is exactly what is supposed to happen. Econ 101.
  • Was Apple’s entry automatically good just because it was entry? Emphatically no. There is no rule in antitrust that entry is inherently good, and a number of strong rules to the contrary (consider, for example, the very foundation of the Brook Group predation standard, which is that we should provide no legal protection to less efficient competitors, including entrants). That is for a simple reason: entry is good when causes quality-adjusted price to go down. The opposite occurred in Apple[***]
  • Is Amazon the real villain, so obviously that we should allow its suppliers to regulate its power through horizontal cartel? I rather think not. While I have no doubt that Amazon is a dangerous entity, that probably will merit scrutiny on any number of grounds now or in the future, it seems implausible that it priced e-books predatorily, surely not on the legal standard that currently prevails in the United States. In fact, an illuminating theme in The Everything Store, Brad Stone’s comprehensive study of the company, was the ubiquity of supplier allegations of Amazon’s predation in all kinds of products, complaints that have gone on throughout the company’s two-decade existence. I don’t believe Amazon is any hero or that it poses no threats, but what it’s done in these cases is just charge lower prices. It’s been able to do so in a sustained manner mainly through innovation in distribution. And in any case, whether Amazon is big and bad or whatever, the right tool to constrain it is not a price fixing cartel. No regulator cares less about the public interest.
  • Does it make the case special in some way that a technological change drove the defendants to their conspiracy? No. The technological change afoot was in effect just a change in costs. It is much cheaper to deliver content electronically than in hard copy, not least because as things have unfolded, consumers have actually paid for and own most of the infrastructure. To that extent there’s nothing different about Apple than any case in which an innovation in production or distribution has given one player a cost advantage. In fact, the publishers’ primary need to defend against pricing of e-books at some measure of their actual cost is that the publishers’ whole structure is devoted to an expensive intermediating function that becomes largely irrelevant with digital distribution.
  • Is there reason to believe that a horizontal cartel orchestrated by a powerful distributor will achieve better quality-adjusted prices, which I take to be Geoff Manne’s overall theme? I mean, come on. This is essentially a species of destructive competition argument, that otherwise healthy markets can be so little trusted efficiently to supply products that customers want that we’ll put the government to a full rule of reason challenge to attack a horizontal cartel? Do we believe in competition at all?
  • Should it matter that valuable cultural institutions may be at risk, including the viability of paper books, independent bookstores, and perhaps the livelihoods of writers or even literature itself? This seems more troubling than the other points, but hardly is unique to the case or a particularly good argument for self-help by cartel. Consider, if you will, another, much older case. The sailing ship industry was thousands of years old and of great cultural and human significance when it met its demise in the 1870s at the hands of the emerging steamship industry. Ships that must await the fickle winds cannot compete with those that can offer the reliable, regular departures that shipper customers desire. There followed a period of desperate price war following which the sail industry was destroyed. That was sad, because tall-masted sailing ships are very swashbuckling and fun, and were entwined in our literature and culture. But should we have allowed the two industries to fix their prices, to preserve sailing ships as a living technology?

There are other arguments, and we could keep working through them one by one, but the end result is the same. The arguments mostly are weak, and even those with a bit more heft do nothing more than pose the problem inherent in that very last point. Healthy markets sometimes produce pain, with genuinely regrettable consequences.  But that just forces us to ask: do we believe in competition or don’t we?

___________

[*] Except possibly for one narrow issue, Apple is at this point emphatically a fact case, and the facts were resolved on an extensive record by an esteemed trial judge, in a long and elaborate opinion, and left undisturbed on appeal (even in the strongly worded dissent). The one narrow issue that is actually a legal one, and that Apple mainly stresses in its petition—whether in the wake of Leegin the hub in a hub-and-spoke arrangement can face per se liability—is one on which I guess people could plausibly disagree. But even when that is the case this Court virtually never grants cert. in the absence of a significant circuit split, and here there isn’t one.

Apple points only to one other Circuit decision, the Third Circuit’s Toledo Mack. It is true as Apple argues that a passage in Toledo Mack seemed to read language from Leegin fairly broadly, and to apply even when there is horizontal conspiracy at the retail level. But Toledo Mack was not a hub-and-spoke case. While plaintiff alleged a horizontal conspiracy among retailers of heavy trucks, and Mack Trucks later acquiescence in it, Mack played no role in coordinating the conspiracy. Separately, whether Toledo Mack really conflicts with Apple or not, the law supporting the old per se rule against hub-and-spoke conspiracies is pretty strong (take a look, for example, at pp. 17-18 of the Justice Department’s opposition brief.

So, I suppose one might think there is no distinction between a hub-and-spoke and a case like Toledo Mack, in which a manufacturer merely agreed after the fact to assist an existing retail conspiracy, and that there is therefore a circuit split, but that would be rather in contrast to a lot of Supreme Court authority. On the other hand, if there is some legal difference between a hub-and-spoke and the facts of Toledo Mack, then Toledo Mack is relevant only if it is understood to have read Leegin to apply to all “vertical” conduct, including true hub-and-spoke agreements. But that would be a broad reading indeed of both Leegin and Toledo Mack. It would require believing that Leegin reversed sub silentio a number of important decisions on an issue that was not before the Court in Leegin. It would also make a circuit split out of a point that would be only dicta in Toledo Mack. And yes, yes, yes, I know, Judge Jacobs in dissent below himself said that his panel’s decision created a circuit split with Toledo Mack. But I mean, come on. A circuit split means that two holdings are in conflict, not that one bit of dicta commented on some other bit of dicta.

A whole different reason cert. seems improbable is that the issue presented is whether per se treatment was appropriate. But the trial court specifically found the restraint to have been unreasonable under a rule of reason standard. Of course that wouldn’t preclude the Court from reversing the trial court’s holding that the per se rule applies, but it would render a reversal almost certainly academic in the case actually before the Court.

Don’t get me wrong. Nothing the courts do really surprises me anymore, and there are still four members of the Court, even in the wake of Justice Scalia’s passing, who harbor open animosity for antitrust and a strong fondness for Leegin. It is also plausible that those four will see the case Apple’s way, and favor reversing Interstate Circuit (though that seems unlikely to me; read a case like Ticor or North Carolina Dental Examiners if you want to know how Anthony Kennedy feels about naked cartel conduct). But the ideological affinities of the Justices, in and of themselves, just don’t usually turn an otherwise ordinary case into a cert-worthy one.

[**] Yes, yes, yes, Grasshopper, I know, Apple argued that in fact its entry increased quality and consumer choice, and also put on an argument that the output of e-books actually expanded during the period of the publishers’ conspiracy. But, a couple of things. First, as the government observed in some juicy briefing in the case, and Judge Cote found in specific findings, each of Apple’s purported quality enhancements turned out to involve either other firms’ innovations or technological enhancements that appeared in the iPad before Apple ever communicated with the publishers. As for the expanded output argument, it was fairly demolished by the government’s experts, a finding not disturbed even in Judge Jacobs’ dissent.

In any case, any benefit Apple did manage to supply came at the cost of a price increase of fifty freaking percent, across thousands of titles, that were sustained for the entire two years that the conspiracy survived.

[***] There have also been the usual squabbles over factual details that are said to be very important, but these points are especially uninteresting. E.g., the case involved “MFNs” and “agency contracts,” and there is supposed to be some magic in either their vertical nature or the great uncertainty of their consequences that count against per se treatment. There isn’t. Neither the government’s complaint, the district court, nor the Second Circuit attacked the bilateral agreements in and of themselves; on the contrary, both courts emphatically stressed that they only found illegal the horizontal price fixing conspiracy and Apple’s role in coordinating it.

Likewise, some stress that the publisher defendants in fact earned slightly less per price-fixed book under their agency agreements than they had with Apple. Why would they do that, if there weren’t some pro-competitive reason? Simple. The real money in trade publishing was not then or now in the puny e-book sector, but in hard-cover, new-release best sellers, which publishers have long sold at very significant mark-ups over cost. Those margins were threatened by Amazon’s very low e-book prices, and the loss on agency sales was worth it to preserve the real money makers.

The Apple E-Books Antitrust Case: Implications for Antitrust Law and for the Economy — Day 2

February 16, 2016

truthonthemarket.com

We will have a few more posts today to round out the Apple e-books case symposium started yesterday.

You can find all of the current posts, and eventually all of the symposium posts, here. Yesterdays’ posts, in order of posting:

Look for posts a little later today from:

  • Tom Hazlett
  • Morgan Reed
  • Chris Sagers

And possibly a follow-up post or two from some of yesterday’s participants.

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

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

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

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

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

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

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

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

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

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

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

For a few months I have thought that the Apple eBooks case would find an easy fit within the Supreme Court’s antitrust decisions. The case that seems closest to me is Business Electronics v. Sharp Electronics, an unfortunately under-appreciated piece of antitrust precedent. One sign of its under-appreciation is its absence in some recent editions of antitrust casebooks.

In Business Electronics, the Court looked at a vertical relationship in which a manufacturer agreed with one of its retailers to terminate another retailer for failing to comply with the manufacturer’s suggested minimum prices. The Court held that such an agreement could not be ruled per se illegal unless the plaintiff could prove that the non-terminated retailer had agreed with the manufacturer to set its resale price at some level. The Court was reluctant to apply the per se test to this sort of case because of the potential efficiencies that might justify the manufacturer’s minimum retail prices. To allow some leeway for these efficiencies to be realized, the Court erected a high burden of proof under the per se test. Now, of course, the Court no longer applies the per se test to vertical arrangements like that in Business Electronics because of its decision in Leegin to adopt rule of reason analysis for vertical restraints.

The Apple eBooks case falls under Business Electronics. Apple offered the book publishers a contract that left Amazon with a choice of complying with a pricing system closer to the publisher’s preferences or terminating its relationship with the publishers. In other words, the Apple contract, with its famous most-favored-nations clause, effectively presented Amazon with an ultimatum similar to the one observed in Business Electronics. The ultimatum worked: Amazon was forced to comply with the pricing scheme preferred by the publishers and Apple. It follows from Business Electronics, and from Leegin, that the burden of proof in this case should be set high – a bit higher than the trial court set it in this case. Further, Leegin suggests that rule of reason analysis should apply because the relationship at issue is vertical.

Justice Scalia’s passing may have affected the Apple eBooks case already. Scalia was the author of Business Electronics, and presumably the Supreme Court Justice most likely to have noticed the similarity between Business Electronics and Apple eBooks.