Archives For consent order

Today the FTC filed its complaint in federal district court in Washington against Amazon, alleging that the company’s in-app purchasing system permits children to make in-app purchases without parental “informed consent” constituting an “unfair practice” under Section 5 of the FTC Act.

As I noted in my previous post on the case, in bringing this case the Commission is doubling down on the rule it introduced in Apple that effectively converts the balancing of harms and benefits required under Section 5 of the FTC Act to a per se rule that deems certain practices to be unfair regardless of countervailing benefits. Similarly, it is attempting to extend the informed consent standard it created in Apple that essentially maintains that only specific, identified practices (essentially, distinct notification at the time of purchase or opening of purchase window, requiring entry of a password to proceed) are permissible under the Act.

Such a standard is inconsistent with the statute, however. The FTC’s approach forecloses the ability of companies like Amazon to engage in meaningful design decisions and disregards their judgment about which user interface designs will, on balance, benefit consumers. The FTC Act does not empower the Commission to disregard the consumer benefits of practices that simply fail to mimic the FTC’s preconceived design preferences. While that sort of approach might be defensible in the face of manifestly harmful practices like cramming, it is wholly inappropriate in the context of app stores like Amazon’s that spend considerable resources to design every aspect of their interaction with consumers—and that seek to attract, not to defraud, consumers.

Today’s complaint occasions a few more observations:

  1. Amazon has a very strong case. Under Section 5 of the FTC Act, the Commission will have to prevail on all three elements required to prove unfairness under Section 5: that there is substantial injury, that consumers can’t reasonably avoid the injury and that any countervailing benefits don’t outweigh the injury. But, consistent with its complaint and consent order in Apple, the Amazon complaint focuses almost entirely on only the first of these. While that may have been enough to induce Apple to settle out of court, the FTC will actually have to make out a case on reasonable avoidance and countervailing benefits at trial. It’s not at all clear that the agency will be able to do so on the facts alleged here.
  2. On reasonable avoidance, over and above Amazon’s general procedures that limit unwanted in-app purchases, the FTC will have a tough time showing that Amazon’s Kindle Free Time doesn’t provide parents with more than enough ability to avoid injury. In fact, the complaint doesn’t mention Free Time at all.
  3. Among other things, the complaint asserts that Amazon knew about issues with in-app purchasing by December of 2011 and claims that “[n]ot until June 2014 did Amazon change its in-app charge framework to obtain account holders’ informed consent for in-app charges on its newer mobile devices.” But Kindle Free Time was introduced in September of 2012. While four FTC Commissioners may believe that Free Time isn’t a sufficient response to the alleged problem, it is clearly a readily available, free and effective (read: reasonable) mechanism for parents to avoid the alleged harms. It may not be what the design mavens at the FTC would have chosen to do, but it seems certain that avoiding unauthorized in-app purchases by children was part of what motivated Amazon’s decision to create and offer Free Time.
  4. On countervailing benefits, as Commissioner Wright discussed in detail in his dissent from the Apple consent order, the Commission seems to think that it can simply assert that there are no countervailing benefits to Amazon’s design choices around in-app purchases. Here the complaint doesn’t mention 1-Click at all, which is core to Amazon’s user interface design and essential to evaluating the balance of harms and benefits required by the statute.
  5. Even if it can show that Amazon’s in-app purchase practices caused harm, the Commission will still have to demonstrate that Amazon’s conscious efforts to minimize the steps required to make purchases doesn’t benefit consumers on balance. In Apple, the FTC majority essentially (and improperly) valued these sorts of user-interface benefits at zero. It implicitly does so again here, but a court will require more than such an assertion.
  6. Given these lapses, there is even a chance that the complaint will be thrown out on a motion to dismiss. It’s a high bar, but if the court agrees that there are insufficient facts in the complaint to make out a plausible case on all three elements, Amazon could well prevail on a motion to dismiss. The FTC’s approach in the Apple consent order effectively maintains that the agency can disregard reasonable avoidance and countervailing benefits in contravention of the statute. By following the same approach here in actual litigation, the FTC may well meet resistance from the courts, which have not yet so cavalierly dispensed with the statute’s requirements.

The Wall Street Journal reports this morning that Amazon is getting — and fighting — the “Apple treatment” from the FTC for its design of its in-app purchases:

Amazon.com Inc. is bucking a request from the Federal Trade Commission that it tighten its policies for purchases made by children while using mobile applications.

In a letter to the FTC Tuesday, Amazon said it was prepared to “defend our approach in court,” rather than agree to fines and additional record keeping and disclosure requirements over the next 20 years, according to documents reviewed by The Wall Street Journal.

According to the documents, Amazon is facing a potential lawsuit by the FTC, which wants the Seattle retailer to accept terms similar to those that Apple Inc. agreed to earlier this year regarding so-called in-app purchases.

From what I can tell, the Commission has voted to issue a complaint, and Amazon has informed the Commission that it will not accept its proposed settlement.

I am thrilled that Amazon seems to have decided to fight the latest effort by a majority of the FTC to bring every large tech company under 20-year consent decree. I should say: I’m disappointed in the FTC, sorry for Amazon, but thrilled for consumers and the free marketplace that Amazon is choosing to fight rather than acquiesce.

As I wrote earlier this year about the FTC’s case against Apple in testimony before the House Commerce Committee:

What’s particularly notable about the Apple case – and presumably will be in future technology enforcement actions predicated on unfairness – is the unique relevance of the attributes of the conduct at issue to its product. Unlike past, allegedly similar, cases, Apple’s conduct was not aimed at deceiving consumers, nor was it incidental to its product offering. But by challenging the practice, particularly without the balancing of harms required by Section 5, the FTC majority failed to act with restraint and substituted its own judgment, not about some manifestly despicable conduct, but about the very design of Apple’s products. This is the sort of area where regulatory humility is more — not less — important.

In failing to observe common sense limits in Apple, the FTC set a dangerous precedent that, given the agency’s enormous regulatory scope and the nature of technologically advanced products, could cause significant harm to consumers.

Here that failure is even more egregious. 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. I use Kindle Free Time with my kids and have repeatedly claimed to anyone who will listen that it is the greatest thing since sliced bread. Other consumers must feel similarly. Finally, regardless of all of that, Amazon has nevertheless voluntarily implemented additional notification procedures intended to comply with the Apple settlement, even though it didn’t apply to Amazon.

If the FTC asserts, in the face of all of that, that it’s own vision of what “appropriate” in-app purchase protections must look like is the only one that suffices to meet the standard required by Section 5’s Unfairness language, it is either being egregiously disingenuous, horrifically vain, just plain obtuse, or some combination of the three.

As I wrote in my testimony:

The application of Section 5’s “unfair acts and practices” prong (the statute at issue in Apple) is circumscribed by Section 45(n) of the FTC Act, which, among other things, proscribes enforcement where injury is “not outweighed by countervailing benefits to consumers or to competition.”

And as Commissioner Wright noted in his dissent in the Apple case,

[T]he Commission effectively rejects an analysis of tradeoffs between the benefits of additional guidance and potential harm to some consumers or to competition from mandating guidance…. I respectfully disagree. These assumptions adopt too cramped a view of consumer benefits under the Unfairness Statement and, without more rigorous analysis to justify their application, are insufficient to establish the Commission’s burden.

We won’t know until we see the complaint whether the FTC has failed to undertake the balancing it neglected to perform in Apple and that it is required to perform under the statute. But it’s hard to believe that it could mount a case against Amazon in light of the facts if it did perform such a balancing. There’s no question that Amazon has implemented conscious and consumer-welfare-enhancing design choices here. The FTC’s effort to nevertheless mandate a different design (and put Amazon under a 20 year consent decree) based on a claim that Amazon’s choices impose greater harms than benefits on consumers seems manifestly unsupportable.

Such a claim almost certainly represents an abuse of the agency’s discretion, and I expect Amazon to trounce the FTC if this case goes to trial.

James Cooper is Director, Research and Policy at the Law & Economics Center at George Mason University School of Law

The FTC has long been on a quest to find the elusive species of conduct that Section 5 alone can tackle.  A series of early Supreme Court cases interpreting the FTC Act – the most recent and widely cited of which is more than forty years old (FTC v. Sperry & Hutchinson Co., 405 U.S. 233 (1972)) –appeared to grant the FTC wide ranging powers to condemn methods of competition as “unfair.”[1]  A series of judicial setbacks in the 1980s and early 1990s, however, scaled back Section 5’s domain.[2]

Since 1992, the FTC has continued to define Section 5’s reach internally – through settlements primarily involving two classes of conduct: so-called “invitations to collude” (ITC);[3] and breaches of agreements to disclose or to license standard-essential patents (SEPs).[4] Similar in spirit to ITCs, the Commission has also alleged pure Section 5 violations in cases involving sharing of competitively sensitive information.[5]

In addition to these lines of cases, the FTC has used Section 5 in two additional matters: the “CD MAP” cases, involving the parallel adoption by major record companies of “minimum advertised price” restrictions; and the suit against Intel for engaging in exclusionary conduct, including deception and certain pricing practices.

Absent external appellate review, however, it remains unclear whether Congress intended for these classes of conduct to be illegal as “unfair methods of competition.”  Because settlement with the FTC will be preferable to litigation in a wide array of circumstances, what is considered illegal under Section 5 largely has become whatever at least three Commissioners can agree on.  Accordingly, there is still a relatively large zone in which the FTC can develop this quasi Section 5 common law with little fear of triggering litigation, and the concomitant specter of judicial scrutiny.

The recent Google investigation provides some evidence as to just how large this zone of discretion may be.  Although the Commission eventually decided to close its investigation into Google’s search practices – and was able to extract informal concessions from Google related to “scraping” and failures to facilitate “multihoming” – that the Commission would entertain a case premised on such conduct hints at a willingness to make arguments that clear Sherman Act precedent involving duties to aid rivals does not apply to the Section 5 actions, or that misappropriation can serve as the basis for a Section 5 theory.  The Commission’s settlement with Google concerning breaches of commitments to license SEPs on FRAND terms, moreover, continued its application of antitrust and consumer protection law to contractual disputes between sophisticated businesses.

Parsing the statements in Google suggest at least four directions in which at least one commissioner was willing to expand Section 5 beyond the Sherman Act:  duties to aid rivals, misappropriation, failure to disclose the relationship between data collection and market power, and breach of an agreement to license SEPs on FRAND terms.  Further, in two instances, at least one commissioner additionally was willing to declare the same conduct an unfair act or practice.  This is far from a coherent framework for Section 5.

The FTC’s discretion under Section 5 potentially comes at a steep price.  First, it creates uncertainty.  If businesses are unsure about where the line between legal an illegal behavior is drawn, they rationally will take too much care to avoid violating the law, which in antitrust can mean competing less aggressively.  Second, the more discretion the FTC enjoys to condemn a practice as an unfair method of competition, the more competition will be channeled from the marketplace to 600 Pennsylvania Avenue.  Although this may be a good development for economists and attorneys, it is bad for consumers.

The FTC could go a long way toward solving this problem if it were to take a cue from the history of its consumer protection program.  The FTC’s overreach in the 1970s earned it the moniker “national nanny,” nearly shut the agency down.  As part of a program to instill public – and more importantly Congressional – trust, the FTC adopted a series of binding policy statements that made consumer harm the touchstone of its authority to challenge “unfair or deceptive acts or practices” (UDAP authority).

A similar effort at self-restraint that limits the FTC’s UMC authority could help reduce uncertainty and rent seeking.  Both Commissioners Ohlhausen and Wright should be commended on their impressive efforts to start this discussion.  In my first post, however, I’d like to discuss a more dramatic path that neither has addressed: confining Section 5 to the Sherman Act.

In many ways the search for Section 5’s domain beyond the Sherman Act is a solution in search of a problem.  There is certainly no consensus that the Sherman Act – even after some recent limitations imposed by cases like Twombly, Trinko, and Credit Suisse – is no longer fit for the task of policing anticompetitive conduct.  It may well be that the FTC is trying to sell a product that nobody needs.  Consequently, the costs of abandoning an expansive Section 5 may be small; with the exceptions of ITCs and information sharing involving small firms, the rest of the FTC’s Section 5 portfolio also can be reached under existing Sherman Act theories (albeit with more difficulty), or handled through other bodies of law or self-regulation.

For example, under the D.C. Circuit’s decision in Rambus, Section 2 is available for cases involving deception at the time of the standard adoption that materially affected the choice of standard.[6] Accordingly, a Section 2 case could be made out if the Commission could show that the defendant either concealed an SEP or if a FRAND commitment was made in bad faith and affected the choice of standard.  Even if deception cannot be show, breaches of FRAND commitments involving SEPs that result in hold-up necessarily involve legal review; the court (or ITC) must decide whether to grant the SEP holder’s request for an injunction (or an exclusion order), and the alleged infringer has opportunities to raise a variety of contract and patent law objections.  Likewise, bundling, predatory pricing, and deception claims like those in Intel are clearly cognizable under Sherman Section 2 (which is why Intel was pled both ways).

Confining Section 5 to the Sherman Act would also have the advantage reduce arbitrage opportunities between the FTC and the Antitrust Division.  As Commissioner Ohlhausen has noted, if the same conduct results in different legal treatment depending on which agency wins clearance – as it arguably would have in the Google investigation – these routine bureaucratic procedures could have substantial influence on ultimate liability.

Although this conduct is reachable under the Sherman Act, many of the cases would be difficult to win.  To the extent that these Sherman Act rules reasonably sort anticompetitive from procompetitive or benign conduct, however, forcing the Commission to satisfy Sherman Act standards would assure that its actions promote consumer welfare.

The only types of conduct that clearly slip out of the FTC’s reach when Section 5 is confined to the Sherman Act are ITCs and information sharing involving firms with low market shares.  The costs of letting this conduct go, however, are likely minimal.  Although most would agree that this conduct is  worth stopping, the FTC has pursued less than ten of these cases in the past 20 years.  Even including deterrence effects, removing ITCs and information sharing cases from the FTC portfolio is unlikely to cause a great deal of consumer harm.  Most managers are probably aware that price fixing is illegal, and it is doubtful that anybody proposes a cartel or shares information without hoping that the other party will get on board.  At the same time, these Section 5 cases are obscure – lurking in a series of consent orders on the FTC’s web site.  The sophisticated antitrust bar likely is familiar with this strain of Section 5 activity, but outside of the clients counseled by top tier law firms, it is not obvious that many businesses are aware of there existence.  Without awareness, there can be no deterrence.  Further, if either of these acts leads to a conspiracy or significant market power, it will be reachable under the Sherman Act.

Finally, removing the FTC’s Section 5 authority will not diminish its role as an antitrust norm creator.  Indeed, over its near 100-year history, however, the FTC has not used Section 5 to implement any important antitrust norms.[7]  That is not to say that the FTC has lacked influence over the development of antitrust jurisprudence – to the contrary, it clearly has, but within the confines of the Sherman Act.  For example, the FTC has made major positive contribution in the fields of joint conduct,[8] state action,[9] Noerr-Pennington,[10] the treatment of professional regulation,[11] and most recently in the context of pharmaceutical reverse settlements.[12]

Of course, if Section 5 is to offer nothing beyond the Sherman Act, that begs the question of whether the FTC is needed at all? In this manner, the quest for a species of harmful conduct that is reachable only through Section 5 is an existential one.  Does it make sense to have two agencies enforcing the same law?[13]  Probably not.  The FTC’s comparative advantage over DOJ lays in its research capability, and of course its consumer protection mission.  Accordingly, stripped of a unique antirust enforcement authority, one possible reorganization would be to house enforcement in DOJ, with the FTC providing competition and consumer protection policy R&D that would feed into case selection designed to improve these bodies of law.

However attractive it may be from a policy standpoint, jettisoning Section 5 beyond the Sherman Act is a political non-starter; Congress would never permit the FTC to abrogate its UMC power.  Indeed, recall the nasty fight that erupted when the FTC and DOJ attempted to reach a clearance agreement in 2002.  Accordingly, a more realistic path for the Commission to take would be to spell out the circumstances under which it would consider a stand alone Section 5 case.[14]  I will turn to this in my next posting.


[1] See, e.g., FTC v. Sperry & Hutchinson Co., 405 U.S. 233 (1972); William E. Kovacic & Marc Winerman, Competition Policy and the Application of Section 5 of the Federal Trade Commission Act, 76 Antitrust L.J. 929, 930-31 (2010).

[2] FTC v. Boise Cascade, 637 F.2d 573, 581 (9th Cir. 1980); Official Airline Guides, Inc. v. FTC, 630 F.2d 920 (2d. Cir. 1980); E.I DuPont de Nemours & Co. v. FTC, 729 F.2d 128 (2d Cir. 1984).  The FTC’s last judicially decided Section 5 action was in 1992. FTC v. Abbott Labs, 853 F. Supp. 526 (D.D.C. 1992).

[3] In re U-Haul Int’l, Inc. (June 9, 2010); In re Valassis Communications, Inc. (April 19, 2006); In re Stone Container Corp. (June 3, 1998); In re Precision Moulding Co. (Sept. 3, 1996); In re YKK(USA) (July 1, 1993); In re A.E. Clevite, Inc. (June 8, 1993); In re Quality Trailer Prods. Corp. (Nov. 5, 1992).

[4] In re Dell Computer (1996); In re Negotiated Data Systems, Inc. (2008); In re Robert Bosch GmbH (2012); In re Google, Inc. (2013).

[5] In re Bosely (2013); In re Nat’l Ass’n of Music Merchants (2009).

[6] Rambus Inc. v. FTC, 522 F.3d 456 (D.C. Cir. 2008); see also Broadcom Corp. v. Qualcomm Inc., 501 F.3d 297 (3rd Cir. 2007); Microsoft, 253 F.3d 3, 76 (D.C. Cir. 2001); Conwood Co. v. U.S. Tobacco Co., 290 F.3d 768 (6th Cir. 2002).

[7] See Kovaic & Winerman, supra note__, at 941 (“The FTC’s record of appellate litigation involving applications of Section 5 that go beyond prevailing antitrust norms is uninspiring.”).

[8] See Polygram Holding, Ltd. v. FTC, 416 F.3d 29 (D.C. Cir. 2005).

[9] See FTC v. Ticor Ins. Co, 504 U.S. 621 (1992); North Carolina Board of Dental Examiners v. FTC, No. 12-1172 (4th Cir. May 31, 2013).

[10] See FTC v. Phoebe Putney Healthcare System, Inc. (Feb. 13, 2013); FTC v. Superior Court Trial Lawyers Ass’n, 493 U.S. 411 (1990).

[11] See FTC v. Indiana Federation of Dentists, 476 U.S. 447 (1986); FTC v. California Dental Association, 526 U.S. 756 (1999).

[12] FTC v. Actavis, Inc., Slip Op. No. 12-416 (June 16, 2013).

[13] See Kovacic & Winerman

[14] Commissioners Ohlhausen and Wright have recently begun this discussion.  See __.

On July 24, the Federal Trade Commission issued a modified complaint and consent order in the Google/Motorola case. The FTC responded to the 25 comments on the proposed Order by making several amendments, but the Final Order retains the original order’s essential restrictions on injunctions, as the FTC explains in a letter accompanying the changes. With one important exception, the modifications were primarily minor changes to the required process by which Google/Motorola must negotiate and arbitrate with potential licensees. Although an improvement on the original order, the Complaint and Final Order’s continued focus on the use of injunctions to enforce SEPs presents a serious risk of consumer harm, as I discuss below.

The most significant modification in the new Complaint is the removal of the original UDAP claim. As suggested in my comments on the Order, there is no basis in law for such a claim against Google, and it’s a positive step that the FTC seems to have agreed. Instead, the FTC ended up resting its authority solely upon an Unfair Methods of Competition claim, even though the Commission failed to develop any evidence of harm to competition—as both Commissioner Wright and Commissioner Ohlhausen would (sensibly) require.

Unfortunately, the FTC’s letter offers no additional defense of its assertion of authority, stating only that

[t]he Commission disagrees with commenters who argue that the Commission’s actions in this case are outside of its authority to challenge unfair methods of competition under Section 5 and lack a limiting principle. As reflected in the Commission’s recent statements in Bosch and the Commission’s initial Statement in this matter, this action is well within our Section 5 authority, which both Congress and the Supreme Court have expressly deemed to extend beyond the Sherman Act.

Another problem, as noted by Commissioner Ohlhausen in her dissent from the original order, is that

the consent agreement creates doctrinal confusion. The Order contradicts the decisions of federal courts, standard-setting organizations (“SSOs”), and other stakeholders about the availability of injunctive relief on SEPs and the meaning of concepts like willing licensee and FRAND.

The FTC’s statements in Bosch and this case should not be thought of as law on par with actual court decisions unless we want to allow the FTC to determine the scope of its own authority unilaterally.

This is no small issue. On July 30, the FTC used the Google settlement, along with the settlement in Bosch, as examples of the FTC’s authority in the area of policing SEPs during a hearing on the issue. And as FTC Chairwoman Ramirez noted in response to questions for the record in a different hearing earlier in 2013,

Section 5 of the FTC Act has been developed over time, case-by-case, in the manner of common law. These precedents provide the Commission and the business community with important guidance regarding the appropriate scope and use of the FTC’s Section 5 authority.

But because nearly all of these cases have resulted in consent orders with an administrative agency and have not been adjudicated in court, they aren’t, in fact, developed “in the manner of common law.” Moreover, settlements aren’t binding on anyone except the parties to the settlement. Nevertheless, the FTC has pointed to these sorts of settlements (and congressional testimony summarizing them) as sufficient guidance to industry on the scope of its Section 5 authority. But as we noted in our amicus brief in the Wyndham litigation (in which the FTC makes this claim in the context of its “unfair or deceptive acts or practices” authority):

Settlements (and testimony summarizing them) do not in any way constrain the FTC’s subsequent enforcement decisions; they cannot alone be the basis by which the FTC provides guidance on its unfairness authority because, unlike published guidelines, they do not purport to lay out general enforcement principles and are not recognized as doing so by courts and the business community.

Beyond this more general problem, the Google Final Order retains its own, substantive problem: considerable constraints upon injunctions. The problem with these restraints are twofold: (1) Injunctions are very important to an efficient negotiation process, as recognized by the FTC itself; and (2) if patent holders may no longer pursue injunctions consistently with antitrust law, one would expect a reduction in consumer welfare.

In its 2011 Report on the “IP Marketplace,” the FTC acknowledged the important role of injunctions in preserving the value of patents and in encouraging efficient private negotiation.

Second, the credible threat of an injunction deters infringement in the first place. This results from the serious consequences of an injunction for an infringer, including the loss of sunk investment. Third, a predictable injunction threat will promote licensing by the parties. Private contracting is generally preferable to a compulsory licensing regime because the parties will have better information about the appropriate terms of a license than would a court, and more flexibility in fashioning efficient agreements. But denying an injunction every time an infringer’s switching costs exceed the economic value of the invention would dramatically undermine the ability of a patent to deter infringement and encourage innovation. For this reason, courts should grant injunctions in the majority of cases.

Building on insights from Commissioner Wright and Professor Kobayashi, I argued in my comments that injunctions create conditions that

increase innovation, the willingness to license generally and the willingness to enter into FRAND commitments in particular–all to the likely benefit of consumer welfare.

Monopoly power granted by IP law encourages innovation because it incentivizes creativity through expected profits. If the FTC interprets its UMC authority in a way that constrains the ability of patent holders to effectively police their patent rights, then less innovation would be expected–to the detriment of consumers as well as businesses.

And this is precisely what has happened. Innovative technology companies are responding to the current SEP enforcement environment exactly as we would expect them to—by avoiding the otherwise-consumer-welfare enhancing standardization process entirely.

Thus, for example, at a recent event sponsored by Global Competition Review (gated), representatives from Nokia, Ericsson, Siemens and Qualcomm made no bones about the problems they see and where they’re headed if they persist:

[Jenni Lukander, global head of competition law at Nokia] said the problem of “free-riding”, whereby technology companies adopt standard essential patents (SEPs) without complying with fair, reasonable and non-discriminatory (FRAND) licensing terms was a “far bigger problem” than patent holders pursuing injunctive relief. She said this behaviour was “unsustainable”, as it discouraged innovation and jeopardised standardisation.

Because of the current atmosphere, Lukander said, Nokia has stepped back from the standardisation process, electing either not to join certain standard-setting organisations (SSOs) or not to contribute certain technologies to these organisations.

The fact that every licence negotiation takes places “under the threat of injunction litigation” is not a sign of failure, said Lukander, but an indicator of the system working “as it was designed to work”.

This, said [Dan Hermele, director of IP rights and licensing for Qualcomm Europe], amounted to “reverse hold-up”. “The licensor is pressured to accept less than reasonable licensing terms due to the threat of unbalanced regulatory intervention,” he said, adding that the trend was moving to an “infringe and litigate model”, which threatened to harm innovators, particularly small and medium-sized businesses, “for whom IPR is their life blood”.

Beat Weibel, chief IP counsel at Siemens, said…innovation can only be beneficial if it occurs within a “safe and strong IP system,” he said, where a “willing licensee is favoured over a non-willing licensee” and the enforcer is not a “toothless tiger”.

It remains to be seen if the costs to consumers from firms curtailing their investments in R&D or withholding their patents from the standard-setting process will outweigh the costs (yes, some costs do exist; the patent system is not frictionless and it is far from perfect, of course) from the “over”-enforcement of SEPs lamented by critics. But what is clear is that these costs can’t be ignored. Reverse hold-up can’t be wished away, and there is a serious risk that the harm likely to be caused by further eroding the enforceability of SEPs by means of injunctions will significantly outweigh whatever benefits it may also confer.

Meanwhile, stay tuned for tomorrow’s TOTM blog symposium on “Regulating the Regulators–Guidance for the FTC’s Section 5 Unfair Methods of Competition Authority” for much more discussion on this issue.

Co-authored with Berin Szoka

FTC Commissioner Wright issued today his Policy Statement on enforcement of Section 5 of the FTC Act against Unfair Methods of Competition (UMC)—the one he promised in April. Wright introduced the Statement in an important policy speech this morning before the Executive Committee Meeting of the New York State Bar Association’s Antitrust Section. Both the Statement and the speech are essential reading, and, collectively, they present a compelling and comprehensive vision for Section 5 UMC reform at the Commission.

As we’ve been saying for some time, and as Wright notes at the outset of his Statement:

In order for enforcement of its unfair methods of competition authority to promote consistently the Commission’s mission of protecting competition, the Commission must articulate a clear framework for its application.

Significantly, in addition to offering important certainty to guide business actions, Wright bases his proposed Policy Statement on the error cost framework:

The Commission must formulate a standard that distinguishes between acceptable business practices and business practices that constitute an unfair method of competition in order to provide firms with adequate guidance as to what conduct may be unlawful.  Articulating a clear and predictable standard for what constitutes an unfair method of competition is important because the Commission’s authority to condemn unfair methods of competition allows it to break new ground and challenge conduct based upon theories not previously enshrined in Sherman Act or Clayton Act jurisprudence.

As far as we know, this Statement is the most significant effort yet to cabin FTC enforcement decisions within a coherent error-cost framework, and it is especially welcome.

Ironically, this is former Chairman Jon Leibowitz’s true legacy: His efforts to expand Section 5 to challenge conduct under novel theories, devoid of economic grounding and without proof of anticompetitive harm (in cases like Intel, N-Data and Google, among others) brought into stark relief the potential risks of an unfettered, active Section 5. Commissioner Wright’s Statement can be seen as the unintended culmination of—and backlash against—Leibowitz’s Section 5 campaign.

Particularly given the novelty of circumstances that might come within Section 5’s ambit, the error-cost minimizing structure of Commissioner Wright’s proposed Statement is enormously important. As one of us (Manne) notes in the paper, Innovation and the Limits of Antitrust (co-authored with then-Professor Wright),

Both product and business innovations involve novel practices, and such practices generally result in monopoly explanations from the economics profession followed by hostility from the courts (though sometimes in reverse order) and then a subsequent, more nuanced economic understanding of the business practice usually recognizing its procompetitive virtues.

And as Wright’s Statement notes,

This is particularly true if business conduct is novel or takes place within an emerging or rapidly changing industry, and thus where there is little empirical evidence about the conduct’s potential competitive effects.

The high cost and substantial risk of over-enforcement arising from unbounded Section 5 authority counsel strongly in favor of Wright’s Statement restricting Section 5 to minimize these error costs.

Thus, while the specifics matter, of course, the real import of Commissioner Wright’s Statement is in some ways structural: If adopted, it would both bring much needed, basic guidance to the scope of the FTC’s Section 5 authority; just as important, it would constrain (an important aspect of) the FTC’s enforcement discretion within the error cost framework, bringing the sound economic grounding of antitrust law and economics to Section 5, benefiting consumers as well as commerce generally:

This Policy Statement benefits both consumers and the business community by relying on modern economics and antitrust jurisprudence to strengthen the agency’s ability to target anticompetitive conduct and provide clear guidance about the contours of the Commission’s Section 5 authority.

For Wright, this is about saving Section 5 from its ill-defined and improperly deployed history. As he noted in his speech this morning,

In undertaking this task, I think it is important to recall why the Commission’s use of Section 5 has failed to date. In my view, this failure is principally because the Commission has sought to do too much with Section 5, and in so doing, called into serious question whether it has any limits whatsoever. In order to save Section 5, and to fulfill the vision Congress had for this important statute, the Commission must recast its unfair methods of competition authority with an eye toward regulatory humility in order to effectively target plainly anticompetitive conduct….. I believe that doing anything less would betray our obligation as responsible stewards of the Commission and its competition mission, and may ultimately result in the Commission having its Section 5 authority defined for it by the courts, or worse, having that authority completely revoked by Congress.

This means circumscribing the FTC’s Section 5 authority to limit enforcement to cases where the Commission shows both actual harm to competition and the absence of cognizable efficiencies.

The Status Quo

Both together and separately, we’ve discussed the problems with the Section 5 status quo in numerous places, including:

To summarize: The problem is that Section 5 enforcement standards in the unfairness context are non-existent. Former Chairman Jon Leibowitz and former Commissioner Tom Rosch, in particular, have, in several places, argued for expanded use of Section 5, both as a way around judicial limits on the scope of Sherman Act enforcement, as well as as an affirmative tool to enforce the FTC’s mandate. As the Commission’s statement in the N-Data case concluded:

We recognize that some may criticize the Commission for broadly (but appropriately) applying our unfairness authority to stop the conduct alleged in this Complaint. But the cost of ignoring this particularly pernicious problem is too high. Using our statutory authority to its fullest extent is not only consistent with the Commission’s obligations, but also essential to preserving a free and dynamic marketplace.

The problem is that neither the Commission, the courts nor Congress has defined what, exactly, the “fullest extent” of the FTC’s statutory authority is. As Commissioner Wright noted in this morning’s speech,

In practice, however, the scope of the Commission’s Section 5 authority today is as broad or as narrow as a majority of the commissioners believes that it is.

The Commission’s claim that it applied its authority “broadly (but appropriately)” in N-Data is unsupported and unsupportable. As Commissioner Ohlhausen put it in her dissent in In re Bosch,

I simply do not see any meaningful limiting principles in the enforcement policy laid out in these cases. The Commission statement emphasizes the context here (i.e. standard setting); however, it is not clear why the type of conduct that is targeted here (i.e. a breach of an allegedly implied contract term with no allegation of deception) would not be targeted by the Commission in any other context where the Commission believes consumer harm may result. If the Commission continues on the path begun in N-Data and extended here, we will be policing garden variety breach-of-contract and other business disputes between private parties….

It is important that government strive for transparency and predictability. Before invoking Section 5 to address business conduct not already covered by the antitrust laws (other than perhaps invitations to collude), the Commission should fully articulate its views about what constitutes an unfair method of competition, including the general parameters of unfair conduct and where Section 5 overlaps and does not overlap with the antitrust laws, and how the Commission will exercise its enforcement discretion under Section 5. Otherwise, the Commission runs a serious risk of failure in the courts and a possible hostile legislative reaction, both of which have accompanied previous FTC attempts to use Section 5 more expansively.

This consent does nothing either to legitimize the creative, yet questionable application of Section 5 to these types of cases or to provide guidance to standard-setting participants or the business community at large as to what does and does not constitute a Section 5 violation. Rather, it raises more questions about what limits the majority of the Commission would place on its expansive use of Section 5 authority.

Commissioner Wright’s proposed Policy Statement attempts to remedy these defects, and, in the process, explains why the Commission’s previous, broad applications of the statute are not, in fact, appropriate.

Requirement #1: Harm to Competition

It should go without saying that anticompetitive harm is a basic prerequisite of the FTC’s UMC enforcement. Sadly, however, this has not been the case. As the FTC has, in recent years, undertaken enforcement actions intended to expand its antitrust authority, it has interpreted far too expansively the Supreme Court’s statement in FTC v. Indiana Federation of Dentists that Section 5 contemplates

not only practices that violate the Sherman Act and the other antitrust laws, but also practices that the Commission determines are against public policy for other reasons.

But “against public policy for other reasons” does not mean “without economic basis,” and there is no indication that Congress intended to give the FTC unfettered authority unbounded by economically sensible limits on what constitutes a cognizable harm. As one of us (Manne) has written,

Following Sherman Act jurisprudence, traditionally the FTC has understood (and courts have demanded) that antitrust enforcement . . . requires demonstrable consumer harm to apply. But this latest effort reveals an agency pursuing an interpretation of Section 5 that would give it unprecedented and largely-unchecked authority. In particular, the definition of “unfair” competition wouldn’t be confined to the traditional antitrust measures — reduction in output or an output-reducing increase in price — but could expand to, well, just about whatever the agency deems improper.

Commissioner Wright’s Statement and its reasoning are consistent with Congressional intent on the limits of the “public policy” rationale in Section 5’s “other” unfairness authority, now enshrined in Section 45(n) of the FTC Act:

The Commission shall have no authority under this section or section 57a of this title to declare unlawful an act or practice on the grounds that such 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.

While not entirely foreclosing the possibility of other indicia of harm to competition, Wright provides a clear statement of what would constitute Section 5 UMC harm under his standard:

Conduct that results in harm to competition, and in turn, in harm to consumer welfare, typically does so through increased prices, reduced output, diminished quality, or weakened incentives to innovate.

This means is that, among other things, “reduction in consumer choice” is not, by itself, a cognizable harm under Section 5, just as it is not under the antitrust laws. As one of us (Manne) has discussed previously:

Most problematically, Commissioner Rosch has suggested that Section Five could address conduct that has the effect of “reducing consumer choice” without requiring any evidence that conduct actually reduces consumer welfare…. Troublingly, “reducing consumer choice” seems to be a euphemism for “harm to competitors, not competition,” where the reduction in choice is the reduction of choice of competitors who may be put out of business by a competitor’s conduct.

The clear limit on “consumer choice” claims contemplated by Wright’s Statement is another of its important benefits.

But Wright emphatically rejects proposals to limit Section 5 to mean only what the antitrust laws themselves mean. Section 5 does extend beyond the limits of the antitrust laws in encompassing conduct that is likely to result in harm to competition, although it hasn’t yet.

Because prospective enforcement of Section 5 against allegedly anticompetitive practices that may turn out not to be harmful imposes significant costs, Wright very nicely here also incorporates an error cost approach, requiring a showing of greater harm where the risk of harm is lower:

When the act or practice has not yet harmed competition, the Commission’s assessment must include both the magnitude and probability of competitive harm.  Where the probability of competitive harm is smaller, the Commission will not find an unfair method of competition without reason to believe the act or practice poses a risk of substantial harm.

In this category are the uncontroversial “invitation to collude” cases long agreed by just about everyone to be within the ambit of Section 5. But Commissioner Wright also suggests Section 5 is appropriate to prevent

the use by a firm of unfair methods of competition to acquire market power that does not yet rise to the level of monopoly power necessary for a violation of the Sherman Act.

This is somewhat more controversial as it contemplates (as the Statement’s illustrative examples make clear) deception that results in the acquisition of market power.

But most important to note is that, while deception was the basis for the Commission’s enforcement action in Rambus (later reversed by the D.C. Circuit), Commissioner Wright’s Statement would codify the important limitation (partly developed in Wright’s own work) on such cases that the deception must be the cause of an acquisition of market power.

Requirement #2: Absence of Cognizable Efficiencies

The real work in Wright’s Statement is done by the limitation on UMC enforcement in cases where the complained-of practice produces cognizable efficiencies. This is not a balancing test or a rule of reason. It is a safe harbor for cases where conduct is efficient, regardless of its effect on competition otherwise:

The Commission therefore creates a clear safe harbor that provides firms with certainty that their conduct can be challenged as an unfair method of competition only in the absence of efficiencies.

As noted at the outset, this is the most important and ambitious effort we know of to incorporate the error cost framework into FTC antitrust enforcement policy. This aspect of the Statement takes seriously the harm that can arise from the agency’s discretion, uncertainty over competitive effects (especially in “likely to cause” cases) and the imbalance of power and costs inherent in the FTC’s Part III adjudication to tip the scale back toward avoidance of erroneous over-enforcement.

Importantly, Commissioner Wright called out the last of these in his speech this morning, describing the fundamental imbalance that his Statement seeks to address:

The uncertainty surrounding the scope of Section 5 is exacerbated by the administrative procedures available to the Commission for litigating unfair methods claims. This combination gives the Commission the ability to, in some cases, take advantage of the uncertainty surrounding Section 5 by challenging conduct as an unfair method of competition and eliciting a settlement even though the conduct in question very likely would not violate the traditional federal antitrust laws. This is because firms typically will prefer to settle a Section 5 claim rather than going through lengthy and costly administrative litigation in which they are both shooting at a moving target and have the chips stacked against them. Such settlements only perpetuate the uncertainty that exists as a result of ambiguity associated with the Commission’s Section 5 authority by encouraging a process by which the contours of the Commission’s unfair methods of competition authority are drawn without any meaningful adversarial proceeding or substantive analysis of the Commission’s authority.

In essence, by removing the threat of Section 5 enforcement where efficiencies are cognizable, Wright’s Statement avoids the risk of Type I error, prioritizing the possible realization of efficiencies over possible anticompetitive harm with a bright line rule that avoids attempting to balance the one against the other:

The Commission employs an efficiencies screen to establish a test with clear and predictable results that prevents arbitrary enforcement of the agency’s unfair methods of competition authority, to focus the agency’s resources on conduct most likely to harm consumers, and to avoid deterring consumer welfare-enhancing business practices.

Moreover, the FTC bears the burden of demonstrating that its enforcement meets the efficiencies test, ensuring that the screen doesn’t become simply a rule of reason balancing:

The Commission bears the ultimate burden in establishing that the act or practice lacks cognizable efficiencies. Once a firm has offered initial evidence to substantiate its efficiency claims, the Commission must demonstrate why the efficiencies are not cognizable.

Fundamentally, as Commissioner Wright explained in his speech,

Anticompetitive conduct that lacks cognizable efficiencies is the most likely to harm consumers because it is without any redeeming consumer benefits. The efficiency screen also works to ensure that welfare-enhancing conduct is not inadvertently deterred…. The Supreme Court has long recognized that erroneous condemnation of procompetitive conduct significantly reduces consumer welfare by deterring investment in efficiency-enhancing business practices. To avoid deterring consumer welfare-enhancing conduct, my proposed Policy Statement limits the use of Section 5 to conduct that lacks cognizable efficiencies.

The Big Picture

Wright’s proposed Policy Statement is well thought out and much needed. It offers clear guidance for companies navigating the FTC’s murky Section 5 waters, and it offers clear, economically grounded limits on the FTC’s UMC enforcement authority. While preserving a scope of enforcement authority for Section 5 beyond the antitrust statutes (including against deceptive conduct that harms competition without any corresponding efficiency justification), it nevertheless reins in the most troubling abuses of that authority by clearly prohibiting the agency’s unprincipled enforcement actions in cases like N-Data, Google and Rambus, all of which failed to establish a connection between the complained-of conduct and harm to competition or else ignored clear efficiencies (particularly Google).

No doubt some agency watchers will criticize the Statement, labeling it reflexively deregulatory. But remember this isn’t being proposed in a vacuum. Commissioner Wright’s Statement defines only what should be a fairly narrow set of cases beyond the antitrust statutes’ reach. The Sherman Act doesn’t disappear because Section 5 is circumscribed, and the most recent controversial Section 5 cases could all theoretically have been plead solely as Section 2 cases (although they may well have failed).

What does change is the possibility of recourse to Section 5 as a means of avoiding the standards established by the courts in enforcing and interpreting the Sherman Act.

The Statement does not represent a restriction of antitrust enforcement authority unless you take as your starting point the agency’s recent unsupported and expansive interpretation of Section 5—a version of Section 5 that was never intended to, and doesn’t, exist. Wright’s Statement is, rather, a bulwark against unprincipled regulatory expansion: a sensible grounding of a statute with a checkered past and a penchant for mischief.

Chairman Leibowitz and Commissioner Rosch, in defending the use and expansion of Section 5, argued in Intel that it was necessary to circumvent judicial limitations on the enforcement of Section 2 aimed only at private plaintiffs (like, you know, demonstration of anticompetitive harm, basic pleading standards…)—basically the FTC’s “get out of Trinko free” card. According to Leibowitz, the Court’s economically rigorous, error-cost jurisprudence in cases like linkline, Trinko, Leegin, Twombly, and Brook Group were aimed at private plaintiffs, not agency actions:

But I also believe that the result, at least in the aggregate, is that some anticompetitive behavior is not being stopped—in part because the FTC and DOJ are saddled with court-based restrictions that are designed to circumscribe private litigation. Simply put, consumers can still suffer plenty of harm for reasons not encompassed by the Sherman Act as it is currently enforced in the federal courts.

The claim is meritless (as one of us (Manne) discussed here, for example). But it helps to make clear what the problem with current Section 5 standards are: There are no standards, only post hoc rationalizations to justify pursuing Section 2 cases without the cumbersome baggage of its jurisprudential limits.

The recent Supreme Court cases mentioned above are only the most recent examples of a decades-long jurisprudential trend incorporating modern economic thinking into antitrust law and recognizing the error-cost tradeoff. These cases have served to remove certain conduct (at least without appropriate evidence and analysis) from the reach of Section 2 in a measured, accretive fashion over the last 40 years or so. They have by no means made antitrust irrelevant, and the agencies and private plaintiffs alike bring and win cases all the time—and this doesn’t even measure the conduct that is deterred by the threat of enforcement.  The limits on Section 5 suggested by Commissioner Wright’s Statement are marginal limits on the scope of antitrust beyond the Sherman Act, Clayton Act and other statutes. There is nothing in the legislative history or plain language of Section 5 to suggest adopting a more expansive approach, in effect using it to undo what the courts have methodically done.

It is also worth noting that not only the antitrust laws, but also the the Unfair and Deceptive Acts and Practices (UDAP) prong of Section 5 exerts a regulatory constraint on business conduct, proscribing deception, for example, as a consumer protection matter—without having to prove the existence of market power or its abuse. This also forms a piece of the institutional backdrop against which Wright’s proposed Policy Statement must be adjudged.

Wright was a leading critic of the agency’s expansive use of Section 5 before he joined the Commission, both at Truth on the Market as well as in longer writing.  He has, correctly, seen it as a serious problem in need of remedying for quite some time. It is gratifying that Wright is continuing this work now that he is on the Commission, where he is no longer relegated merely to critiquing the agency but is in a position to try to transform it himself.

What remains needed is the political will to move this draft Policy Statement to adoption by the full Commission—something Chairman Ramirez is not likely to embrace without considerable pressure from Congress and/or the antitrust community. In the modest service of fulfilling this need, ICLE and TechFreedom intend to host later this year the first of what we hope will be several workshops on Commissioner Wright’s Statement and the broader topic of Section 5 enforcement reform. If the Commission won’t do it, the private sector will have to step in. For a taste of our perspective, check out the amicus brief we recently filed with FTC law scholars (Todd Zywicki, Paul Rubin and Gus Hurwitz) in the case of FTC v. Wyndham, which may be the first case to really test how the FTC uses is unfairness authority in consumer protection cases.

Last Thursday, the FTC settled a challenge to a company’s acquisitions of two key rivals. The two acquisitions, each of which failed to meet the threshold for required reporting under Hart Scott Rodino, occurred in 2005 and 2008. Because the acquired companies have been fully integrated into the acquirer and all distinct operations have been shut down, it was impossible for the Commission to “unscramble the eggs” by imposing a structural remedy that separates the companies or parts thereof. The Commission therefore opted for a behavioral remedy — i.e., a list of restrictions on how the combined company may operate its business in the future. The purported goal of the behavioral remedy is to enhance consumer welfare by restoring competition that was destroyed by the anticompetitive acquisitions.

Commissioner Josh Wright took exception to a couple of the restrictions in the consent order. In a separate statement, he set forth a principle reflecting his concerns that antitrust implementation be both evidence-based and sensitive to error costs. One hopes that the principle he articulated — a version of the Hippocratic maxim, “First, do no harm” — will influence future FTC decisions on behavioral remedies.

The defendant here was Graco, the leading manufacturer of “fast set equipment” (FSE) used by contractors to apply polyurethane foams and coatings. The two companies it purchased, Gusmer in 2005 and GlasCraft in 2008, were its two closest competitors in the North American market for FSE. Graco’s acquisitions of those companies eliminated almost all market competition. In addition, Graco allegedly coerced and threatened FSE distributors so that they would not carry competitors’ products, and it filed a questionable lawsuit against a rival, Gama/PMC, causing FSE distributors to grow leery of that supplier and drop its products.  These post-acquisition actions have helped cement Graco’s market power by denying its actual and potential rivals access to the distribution networks they need to effectively market their products.

In light of Graco’s post-acquisition conduct, the consent order agreed to Thursday prohibits Graco from threatening, coercing, or retaliating against distributors who carry its rivals’ products.  It also requires settlement of the lawsuit that was impairing Gama/PMC’s access to distributors, and it forbids Graco from bringing a similar suit in the future.

But the order then goes further.  It prohibits Graco from entering into exclusive dealing contracts with distributors, and it places limits on Graco’s freedom to give loyalty discounts to distributors.  (Specifically, it limits the purchase and inventory levels upon which Graco may condition distributor discounts.)

The problem, in Commissioner Wright’s view, was that there was no evidence that these forbidden activities – exclusive dealing arrangements and loyalty discounts – contributed to the absence of competition in the FSE market.  Because exclusive dealing arrangements and loyalty discounts are usually procompetitive, prohibiting their use by Graco in the absence of evidence that they are responsible for the lack of competition in the market or are likely to be used to effect anticompetitive harm rather than to achieve a procompetitive benefit is more likely to hurt than help consumers.

Wright notes (and the Commission acknowledges), for example, that the market for FSE is precisely the sort market in which exclusive dealing arrangements achieve the procompetitive benefit of avoiding “inter-brand free-riding.”  Manufacturers of FSE will enhance total sales if they train distributors on the proper use and various complicated features of FSE.  Consumers benefit from (and sales are increased by) such training, because the distributors pass along their learning to end-user purchasers.  But if one FSE manufacturer trains a distributor on how to use the equipment, other manufacturers whose product is carried by that distributor won’t need to do so themselves.  The possibility that they will “take a free-ride” on the manufacturer providing the training tends to dissuade all manufacturers from providing such training, to the detriment of consumers.  Exclusive dealing helps out by preventing free-riding and thereby assuring a manufacturer that it will receive the full benefit of its training efforts.  By banning exclusive dealing, then, the Commission’s consent order may cause a consumer injury, and there’s no reason to take that risk absent evidence that exclusive dealing has been used – or is likely to be used in the future – to create anticompetitive harm.  First, do no harm!

It is important to note that not including exclusive dealing and loyalty discounts on the list of behaviors prohibited by the consent order would not give Graco free rein to use those practices in a manner that causes anticompetitive foreclosure.  The Commission or a competitor could always challenge a future exclusive dealing arrangement or loyalty discount if there were evidence that the practice had caused anticompetitive harm.  The remainder of the Commission’s behavioral remedy assures that there will be a viable competitor – Gama/PMC – that is in a position to challenge any such conduct, and, in light of the consent order, the Commission and any reviewing court would take any future complaints quite seriously.  Doesn’t it make more sense, then, to limit the behavioral remedy to actions that have contributed to the anticompetitive situation at hand and not ban behaviors that may well inure to the benefit of consumers?  As Commissioner Wright put it:

A minimum safeguard to ensure [that] remedial provisions … restore competition rather than inadvertently reduce it is to require evidence that the type of conduct being restricted has been, or is likely to be, used anticompetitively to harm consumers.

I think Wright’s right on this one.

As a result of the FTC’s “Operation Short Change,” a number of firms and individuals have settled claims that they swindled millions from consumers by making unauthorized charges and debits to their bank accounts.  The FTC press release highlights that, in addition to a $2.08 million fine (judgment suspended due to bankruptcy filing), the FTC barred the principal from engaging in a number of related business activities:

Under the settlement Greenberg is banned from owning, controlling, or consulting for any Internet-related business that handles consumers’ credit card or debit card accounts.  He also is prohibited from making unauthorized charges to consumers’ accounts, making false or misleading statements while selling any goods or services, and using any false or assumed name, including an unregistered, fictitious company name, in his business dealings.

As Douglas Ginsburg and I point out in our piece on Antitrust Sanctions in Competition Policy International, debarment of this sort is common in these FTC enforcement actions, at the SEC for other forms of white collar crime (e.g. debarring a director from sitting on the board of a publicly traded company), and as an antitrust sanction for naked price-fixing in a number of countries, e.g. in the U.K. pursuant to the Company Directors Disqualification Act of 1986.

Debarment, however, is not currently in the mix of antitrust sanctions employed by the DOJ in criminal antitrust enforcement actions.  In the article, we make the case that debarment is desirable from an optimal deterrence perspective:

The U.S. Department of Justice should consider taking a similar approach to sentencing individuals convicted of a criminal violation of § 1 of the Sherman Act. We are aware of no reason for which the Department needs to wait for statutory authority to get started, as did the SEC, by negotiating consent orders providing for debarment.74 Prosecutors might, for example, if the conditions for leniency are met, agree to allow individual defendants to reduce or avoid jail time, in return for debarring them from working as a manager or director of any publicly traded corporation or for any company in a particular industry if it is either located in or sells into the United States.75

Negotiated orders of debarment would allow the Antitrust Division to accrue much of the benefit of a prison sentence—publicizing the offense and keeping the offender from recidivating— without undertaking the risk and cost of a criminal trial. The period of debarment should be calibrated to have the same average deterrent effect as jail.76 Further, as we have pointed out, debarment would bolster currently weak reputational penalties, thereby reducing the need for individual fines, which are less likely to deter efficiently because of individuals’ wealth constraints.

Read the whole thing.

FTC Settlement Finalized

Josh Wright —  2 November 2010

The FTC settlement with Intel has been finalized with one change the Commission’s press release describes as follows:

After considering public comments, the FTC modified the proposed order to allow Intel to manufacture and sell a chip that it had in development before the proposed order was negotiated, but that would violate that order because it does not contain a required interface. The FTC modified the order to allow Intel to ship this product until June 2013. All future generations of this chip must fully comply with all specifications of the final Order.

One interesting point.  On an ABA-sponsored call earlier this month on the FTC settlement, and previously on TOTM, I shared my view that the settlement provisions giving the FTC oversight of Intel chip design would not prevent Intel from altering product design in a way that reduces interoperability so long as it could demonstrate any actual benefit from the design change.  Indeed, the settlement language in V.A reads:

IT IS FURTHER ORDERED that Respondent shall not make any engineering or design change to a Relevant Product if that change (1) degrades the performance of a Relevant Product sold by a competitor of Respondent and (2) does not provide an actual benefit to the Relevant Product sold by Respondent, including without limitation any improvement in performance, operation, cost, manufacturability, reliability, compatibility, or ability to operate or enhance the operation of another product; provided, however, that any degradation of the performance of a competing product shall not itself be deemed to be a benefit to the Relevant Product sold by Respondent. Respondent shall have the burden of demonstrating that any engineering or design change at issue complies with Section V. of this Order.

My interpretation of this language (emphasis added) was, in short, that “and” means that so long as Intel can show that the design change has any of these benefits, the change is not prohibited regardless of its impact on rivals.  Of course, the devil is in the details here for Intel with respect to what type of showing the Commission will require to qualify as an “actual benefit.”  Nonetheless, my interpretation attracted a few questions during the call.

Here’s the interesting point.  The Commission seems to adopt the same interpretation.  In its response letter to VIA, an Intel rival who submitted detailed comments on the settlement (which it generally viewed as not going far enough), the Commission discussed V.A.:

Section V of the Consent Order prohibits Intel from designing or engineering its CPU or GPU products to solely disadvantage competitive or complementary products. This provision addresses allegations in the Complaint that Intel engaged in predatory innovation by cutting off competitors’ access to its CPUs and slowing down various connections to the CPU. The Proposed Consent Order would be violated if a design change degrades performance of a competitive or complementary product and Intel fails to demonstrate an actual benefit to the Intel product at issue. The burden is on Intel to demonstrate that any engineering or design change complies with the terms of Section V.

The emphasis is mine.  The Commission seems to agree with the plain meaning of the settlement language.  So I don’t think this is a surprise.  But I did want to highlight it because the interpretation generated some interesting debate previously.  Whether the “actual benefit” showing is a significant burden or not remains to be seen.  If it is not, whether the laxity of this provision is a good or bad thing, of course, turns on one’s view of Intel’s underlying business conduct and the settlement more generally.  As I’ve written previously, I’m a skeptic of the Commission’s antitrust claims against Intel and the proposition that the remedy here is going to make consumers better off.  In that sense, the suggestion that this provision will be essentially non-binding on Intel mitigates some of the damage here — especially in light of some of the contemplated relief (compulsory licensing of the x86 patent, prohibitions on volume discounts generally, etc.).  On the other hand, for those who believe the FTC was on the right side of the consumer welfare analysis (like VIA), I predict significant dissatisfaction with the outcome.

A colleague raised the possibility that perhaps a settlement that doesn’t make anybody happy is a sign of success?  I doubt it.  But it will be important to watch how some of the more intrusive provisions of the settlement are interpreted over time — and remember, the FTC has significant discretion to attempt to modify the terms as the market develops.

Judge Frank Easterbrook once opined that observing predatory pricing was a bit like seeing a unicorn —  in the sense that it was a phenomena around which there was much lore but not much empirical evidence.  The debate over the current expansion of Section 5 liability increasingly has become about the search for a different sort of “unicorn” — follow-on actions. The conventional wisdom is that private rights of action in the US, ceteris paribus, militate in favor of less aggressive enforcement of Section 2 relative to other countries.  It follows, some have argued, that an expansive view of Section 5 is appropriate because it avoids the social costs —  and in particular the chilling effects on efficient behavior associated with potential antitrust liability — associated with false positives.

On one side of this debate, Commissioners Rosch and Leibowitz have extolled the virtues of Section 5 as  a zone free of collateral consequences.   Indeed, Chairman Leibowitz and Commissioner Rosch have gone so far as to assert that the logic underlying the Supreme Court’s jurisprudence recognizing the social costs of antitrust error should only apply to private plaintiffs, but not the enforcement agencies because the latter know anticompetitive conduct when they see it while generalist judges and juries do not and thus are more prone to costly errors.

As a preliminary matter, I should note that my view is that the Rosch/ Leibowitz claim that antitrust law has been narrowed exclusively because of concerns about private plaintiffs is dramatically overstated at best, and at worst, blatantly inconsistent with the Supreme Court’s jurisprudence which has been remarkably consistent in focusing on the inherent difficulties associated with identifying anticompetitive conduct when discussing error costs and the role they play in setting antitrust rules.  It is certainly true that courts have expressed concerns about abuse of the antitrust laws by private plaintiffs, but it is impossible to read the Supreme Court’s antitrust jurisprudence (see, e.g. Trinko, Nynex, Credit Suisse, Brooke Group, Linkline) without taking away a much the Court’s much more general fear that the social costs of false positives — stemming both from the burdens of antitrust discovery and chilling of efficient, pro-competitive conduct — warrants a reduction in the scope of the antitrust laws.

Holding that point aside for a moment, the primary argument supporting the controversial expansion of Section 5 has been that it does not have collateral consequences because only Section 2 create follow-on opportunities for private plaintiffs.  Section 5, Chairman Leibowitz and Commissioner Rosch tell us, does not present such problems.  The social costs associated with Section 5 follow-ons do not exist. Here is a recent version of that assertion from Commissioner Rosch:

The problem here, however, is that these Supreme Court decisions adversely impact all cases in which public antitrust enforcers proceed under the same statute as private plaintiffs and state enforcers, including, most significantly Sections 1 and 2 of the Sherman Act. The Commission can avoid implicating both of these concerns if it proceeds under Section 5: first, only the Commission (as divorced from private plaintiffs, for example), can proceed under Section 5 and, second, if the Commission
proceeds under its Part 3 administrative process in a Section 5 proceeding, there is no role for the district courts or federal juries to play.

Here’s another version of the case for Section 5 resting on an empirical claim about the lack of collateral consequences:

This is an especially important consideration when federal court private treble damage litigation involving the same conduct is pending or threatened. But is it important whenever there is a reasonable prospect that such a private claim will be filed. A plaintiff cannot rely on favorable Section 5 case law in a federal treble damage action. Neither can a federal district court rely on such a decision because the FTC alone can avail itself of Section 5 at the federal level. Conversely, the spillover effects on federal law enforcement of Supreme Court substantive law jurisprudence that is the product of concern about such treble damage actions can be reduced if the Commission uses Section 5, instead of traditional antitrust law that is equally applicable to private and public plaintiffs.

Whether an expanded Section 5 would lead to collateral consequences is fundamentally an empirical question.  There are two potential sources of collateral consequences that have been discussed.  The first is private actions using FTC Act settlements or judgments to create claims under state consumer protection acts (CPAs), which are often interpreted in light of the FTC Act and allow for both attorneys’ fees and multiple damages. The second is the possibility of follow-ons in which private plaintiffs rely on the Section 5 settlement or judgment in federal court under a traditional antitrust statute such as Section 1 or 2.

Thus far, the debate has focused on the first source: state CPAs.  Commissioner Kovacic first responded to the aggressive use of Section 5 in his dissent in the N-Data settlement, responding to the majority assertion that Section 5 provides a free lunch:

The Commission overlooks how the proposed settlement could affect the application of state statutes that are modeled on the FTC Act and prohibit unfair methods of competition (“UMC”) or unfair acts or practices (“UAP”). The federal and state UMC and UAP systems do not operate in watertight compartments. As commentators have documented, the federal and state regimes are interdependent. [Citations omitted].  By statute or judicial decision, courts in many states interpret the state UMC and UDP laws in light of FTC decisions, including orders. As a consequence, such states might incorporate the theories of liability in the settlement and order proposed here into their own UMC or UAP jurisprudence. A number of states that employ this incorporation principle have authorized private parties to enforce their UMC and UAP statutes in suits that permit the court to impose treble damages for infringements.

As a matter of theory, because treble damage remedies are not generally available for Section 5 violations, overdeterrence is likely to be less of a problem under Section 5 than Section 2. But make no mistake — the difference is one of degree rather than of kind.  And as a practical matter, the difference virtually disappears when private remedies are available under Little FTC Acts, including those that are construed in harmony with Section 5 and allow for multiple damages and attorneys’ fees.

In response to this argument, the Commissioners favoring expansion of Section 5 have played the unicorn card.  The claim is, quite simply, that such state level follow-ons don’t happen.  Unfortunately, this side of the debate has been a data-free zone thus far.  Well, almost data free.  Much has been made about the fact that the N-Data settlement itself did not give rise to private causes of action under any “Little FTC Acts.”  For example, Chairman Leibowitz has pointed to the fact that no plaintiff in N-Data filed under a state consumer protection act as evidence that “Section 5 violators do not find themselves subject to private antitrust actions under federal law— and probably under state baby FTC acts as well—certainly not for treble damages.”  Well, state consumer protection acts do indeed exist.  And there is, as the Searle Report on Private Litigation under CPAs notes, quite a bit of litigation under them.  A systematic empirical evaluation of state CPA litigation to determine how frequent Section 5 follow-on litigation occurs seems like a superior alternative to the current debate.

As a tangent, I find the theoretical underpinnings of the “it doesn’t happen” response both unpersuasive and a little bit odd without systematic data supporting it.  The argument seems to be that the private plaintiffs bar is insufficiently creative, resourceful, or aggressive enough to make use a perfectly operational statute that allows free-riding on the Commission’s efforts, and access to attorneys’ fees and multiple damages.  Has anybody seen a modern public policy debate in which it has been asserted that the private plaintiffs bar is asleep behind the wheel?  Now I’m the first to say that measuring the extent and magnitude of any collateral effects of Section 5 is an important empirical question that really ought to be addressed in detail with a serious study.  But pointing to a particular case (N-Data) where a particular plaintiff chose not to make use of the statute for any number of reasons as evidence that it “doesn’t happen” despite obvious incentives for private plaintiffs to use state acts doesn’t quite do the trick.  The appropriate default presumption, I’d imagine, should be that the plaintiffs bar makes use of these statutes where it is profitable to do so.

Of course — state courts are not the only source of follow-ons.  One might believe that a Commission action under Section 5 would encourage private plaintiffs to proceed under Section 2 (or some other statute, e.g. Robinson-Patman) as well.  We are told that such a possibility is pure theory and a Chicago School figment of the imagination.  Well … not so fast.

Readers might recall that the Commission recently announced a settlement with Transitions Optical in a Section 5 case involving exclusive dealing contracts.  A private class action suit alleging a violation of Section 2 of the Sherman Act has been filed in the Western District of Washington based on the Commission Section 5 settlement.

The class action suit comes a month after the Federal Trade Commission (FTC) reached a settlement with Transitions Optical that bars Transitions Optical from using allegedly anticompetitive practices to maintain its monopoly and increase prices on photochromic lenses. The settlement was accompanied by a “consent agreement” between the FTC and Transitions Optical that includes restrictions on exclusive or preferred customer relationships. Transitions Optical has denied any wrongdoing in the matter. … A Transitions Optical spokesperson said, “It’s not unusual for lawsuits like this to be attempted after consent agreements like ours are filed with the FTC. We remain confident about our company and our business practices and feel that we have always done what is right for the success of all our customers and partners. The continued support we receive from our customers and partners shows, more than anything, that we are working in the best interest of the optical industry overall.”

Similarly, a class action Section 1 complaint has been filed against Guitar Center and the National Association of Music Merchants in the Northern District of Illinois.  In that complaint, which relies heavily on the FTC Section 5 complaint, consent order and press releases throughout, the plaintiff alleges that defendants’ minimum advertised pricing (MAP) policies resulted in collusion and higher prices.

The fact that Section 5 judgments do not automatically result in liability under Sherman Act Section 1 or 2 in federal court makes these follow-ons different in at least some important ways from the state CPAs, where at least in principle, liability is automatic.  However, the debate over whether Section 5 consents are free of collateral consequences doesn’t turn on automatic liability.  Rather, the debate is over whether and to what extent Section 5 consents and judgments generate collateral consequences in the form of follow-ons that can lead to the same treble damages actions that generate the concerns about socially costly false positives in the Section 2 setting.  All parties apparently agree that the the Supreme Court’s jurisprudence reacting to the problem of false positives is a sound and rational approach.   The two federal court cases revealed by a few Google searches, combined with the possibility of state CPA actions which have the advantage of multiplied damages along with automatic liability, suggests that we are not talking about unicorns here. The ratio of theory to evidence in the policy discussion of error costs and Section 5 is greater than optimal.  But the claim that the Commission’s expanded vision of Section 5 is free of those concerns should be subjected to more rigorous empirical testing before accepted as a sound basis for competition policy.

Yesterday, in my contribution to the Antitrust & Competition Policy Blog’s Section 5 symposium, I discussed the FTC’s use of Section 5 to evade the tough standards facing plaintiffs bringing Section 2 claims and how that evasion was likely to cost consumers by stripping out the error-cost protections embedded in modern monopolization law.  I also argued that the Commission’s various justifications for bringing the case under Section 5 were both unpersuasive and unprincipled.  Some of the justifications are to do with the general trend towards favoring Section 5 as a stand alone authority, others rely on the institutional expertise of the Commission relative to judges in federal district court, and still others on the nature of competition in the microprocessor market, e.g. Commissioner Rosch’s claim that the difficulty in distinguishing harm to competitors from harm to competition in this setting supports a Section 5 case.

These purported justifications got me thinking.  There are competing theories of the Commission’s reliance on Section 5.  One is that the choice of statute is driven by dissatisfaction with the error cost protections afforded consumers by demanding rigorous proof of consumer harm under Section 2, the appeal of the evading those requirements, and the various procedural benefits of keeping things “in house.”  The other school of thought is that the Commission, in cases like Intel, is taking a principled approach wherein some features of the Intel case (as Commissioner Rosch argues)  favor application of Section 5.  I’ve already tipped my hand here somewhat that I think the proffered justifications don’t carry much water.  But what would be really nice support for the Commission’s argument is that in similar cases involving vigorous competition between a dominant player and challenging incumbent, involving the same sort of loyalty discounts and market share discounts as the contracts forming the basis of the Intel complaint, the Commission invoked Section 5 on similar reasoning.

So when else has the Commission, faced with business practices involving aggressive competition for distribution, including market share discounts, turned to a less stringent statutory authority than Section 2?

FTC v. McCormick. The similarities between McCormick and Intel are interesting.  Both involve competition for distribution.  Both suppliers arguably have monopoly power in plausible relevant antitrust markets.  Further, the conduct in each case involves  “market share discounts,” or contracts that conditioned the granting of discounts on retail distributors agreeing to commit high percentages of their shelf space to McCormick spice products.  In McCormick’s case, in response to a vigorous price war with its leading rival Burns, McCormick offered significant discounts to its retailers in exchange for shelf space commitments approaching 90 percent in some cases.  Like Intel, the contracts at issue appear to be just a small fraction of the total market.  In McCormick, for example, out of 2000 or so contracts with retailers, the Commission focused on a handful: “in no fewer than five instances . .. by providing different deal rates consisting of preferential upfront ‘slotting’-type payments or allowances, discounts, rebates, deductions, free goods, or other financial benefits to some purchasers of McCormick products including, but not limited to, McCormick’s spice line.”   The FTC’s Complaint against McCormick, like the Complaint against Intel, reads like a conventional monopolization claim:

McCormick has commonly included provisions that, much as is sometimes seen with slotting allowances, restrict the ability of customers to deal in the products of competing spice suppliers. Such provisions typically demand that the customer allocate the large majority of the space devoted to spice products – in some case 90% of all shelf space devoted to packaged spices, herbs, seasonings and flavorings of the kinds offered by McCormick – to McCormick.

So what did the Commission do in McCormick?  Did it bring the case under Section 2?  Section 5?  Or even under a primary-line Robinson-Patman Act claim that would have also required the Commission to meet the stringent Brooke Group requirements?  Nope.  Instead, over the dissent of two Commissioners, McCormick ultimately agreed to a consent order with the FTC preventing its use of discriminatory prices between retailers, i.e. secondary-line injury under the Robinson-Patman Act which required no actual showing of loss of consumer welfare.

In my paper on Antitrust Law and Competition for Distribution, I criticized the FTC for bringing (and extracting the settlement) McCormick under the discredited Robinson-Patman Act at all, but even more worthy of criticism was the decision to evade the traditional consumer welfare standards in favor of the secondary-line injury theory which required no such proof:

The availability of the Act’s weaker standard suggests a backdoor for plaintiffs unable to meet the more stringent burden of proving competitive injury in a monopolization or primary-line claim. While it is doubtful that the FTC’s prosecution of McCormick represents a revitalization of the Act, the prosecution does create uncertainty for manufacturers in the growing number of industries relying on retailer promotional effort and product placement for sales.

Sound familiar?  Here is what I wrote about the Commission’s more recent invocation of a weaker substantive standard when it is unlikely to prevail under Section 2:

The Section 5 enforcement action will cost consumers (win or lose) in at least two ways.  The first is that Commission will expend significant resources litigating a case with Intel involving conduct that has already been limited by a private settlement, exploiting resources that could be used to tackle other (error-cost justified) problems.  The second is that the Commission’s invocation of (and awkward justification for) Section 5 will result in uncertainty which will chill some pro-competitive conduct, including discounting behavior by firms in high-tech industries and across the economy.

Whatever one thinks about the competitive merits of Intel’s underlying conduct, the Commission’s use of Section 5 should be seen for what it is: an attempt to evade requirements to demonstrate consumer harm under Section 2 that exist to protect consumers from the social costs of false positives.  Such an approach is bound to harm competition and consumers in the long run because it gives the Commission the option to apply its “watered down” standard to whatever business conduct it views as potentially problematic.  This approach is a recipe for Type I error and should be rejected by fans of consumer-welfare based antitrust policy.

The justifications offered for bringing McCormick under the Robinson-Patman Act, like the justifications offered for bringing Intel under Section 5, are not persuasive.  And in my view, the fact that the FTC brought claims in these two cases involving very similar conduct under two different statutes over a ten year span suggests to me that the Commission does not have a coherent analytical theory of its approach to competition for distribution cases.  So why the RP Act in McCormick and Section 5 in Intel?  My suspicion is that on the one hand the current debate surrounding the appropriate scope of Section 5 had the Commission looking for a good, high profile case to test its Section 5 authority, write an “expert” Commission opinion on the subject and attempt to persuade the federal court of appeals that eventually hears the case about the right approach to loyalty discounts under Section 2 and 5.  On the other hand, the Robinson-Patman Act has only become increasingly discredited since McCormick in 2000 with the AMC repeal recommendation.  But I remain unpersuaded that the Commission’s choice to bring the case under its Section 5 authority is a principled one.

To borrow and put a twist a line from Justice Potter Stewart, the only consistency I can find in the Commission’s approach to competition for distribution and market share discounts is that it chooses to avoid Section 2!

According to the Wall Street Journal, the FTC is investigating whether retailer Toys-R-Us has violated the antitrust laws by inducing certain manufacturers to set minimum resale prices for their products (i.e., to engage in resale price maintenance, or “RPM”).

The Journal first reports that the Commission “is investigating whether [Toys-R-Us] may have violated an 11-year-old order to abstain from [RPM].” That seems a bit odd, for the law on RPM changed radically in 2007, when the U.S. Supreme Court’s Leegin decision held that the practice, which since 1911 had been deemed automatically illegal, would be subject to antitrust’s more lenient rule of reason. Given the sea change wrought by Leegin, any consent order entered 11 years ago would rest on shaky footing indeed.

[UPDATE: As the first comment below explains, the 11 year-old consent order was not aimed at RPM. I didn’t take a look at the order before drafting this post. I should have done so. Mea culpa. This oversight doesn’t alter my argument in the rest of this post.]

More notably, the Journal reports that the FTC may issue a new complaint against Toys-R-Us “for allegedly trying to fix the price of baby products” sold through its Babies-R-Us unit (“BRU”). This past summer, a federal district court certified a consumer class action against Toys-R-Us based on these same allegations. According to the Journal, the FTC has demanded emails from the discovery record in that action (the “BRU case”).

I’m not surprised that the FTC would want to get involved in the BRU case. The legal standard for evaluating instances of RPM is currently pretty unclear (as I explained in this article), and the FTC has a definite opinion on the issue. In considering whether to modify a pre-Leegin consent order entered in another RPM case (Nine West), the FTC took the position that any RPM initiated by retailers, rather than by the manufacturer, should be presumed illegal. If that’s the standard, then the RPM in the BRU case (which was apparently initiated by retailer BRU) should be illegal, at least presumptively. The FTC probably wants to jump into the case to procure a precedent adopting an “illegal if retailer-initiated” liability rule for RPM.

The court hearing the consumer action against BRU has already endorsed a version of that rule. BRU had argued, consistent with well-accepted economic theory and empirical evidence, that RPM may promote competition, even if it raises consumer prices, because it may induce retailers to provide demand-enhancing, output-increasing services (especially those that might be subject to free-riding by cut-rate dealers). The district court concluded, though, that no such procompetitive benefits can follow from retailer-initiated RPM. Crediting the testimony of plaintiffs’ expert William Comanor, the court reasoned that “when a dominant distributor coerces a manufacturer to implement resale price maintenance — rather than the manufacturer adopting it unilaterally — the restraint has only anticompetitive effects.” Such reasoning would seem to entail a rule of per se illegality for dealer-initiated RPM.

As the BRU court explained, the intuition behind its “illegal if retailer-initiated” rule is that whereas “[m]anufacturer interests may be associated with procompetitive effects (creating demand for their products), … distributor interests are associated only with anticompetitive effects (restricting price competition).” But that intuition is mistaken.

Contrary to the BRU court’s assertion, distributor interests in RPM are not “associated only with anticompetitive effects” like facilitating a retailer-level cartel. High-service retailers, who must charge higher prices to cover the costs of the demand-enhancing services they provide, are the most direct victims of free-riding by low-service, low-cost dealers. While the manufacturer, who wants to ensure point-of-sale services, certainly has an interest in preventing free-riding, so do high-service retailers, who bear the immediate costs of providing the demand-enhancing services. Moreover, such retailers are likely to discover free-riding more quickly than the manufacturer; they will immediately notice when they are losing sales to no-frills dealers. Thus, it should not be surprising that retailers would request RPM to prevent free-riding by low-service dealers and that the manufacturer, seeking to ensure that all dealers earn a margin sufficient to finance desired services, would grant their request.

Consider the retailer-initiated RPM in the BRU case. Because (1) manufacturers make more money as more units are sold to consumers and (2) more units typically will be sold to consumers as the retail price is reduced, BRU’s manufacturers had no interest in having a retail mark-up higher than that necessary to motivate effective retail service. Yet, according to the court’s recitation of the facts, every manufacturer asked by BRU to forbid Internet discounting complied with the retailer’s request. Why did the manufacturers give in to BRU’s demand?

The plaintiffs’ theory, which the district court accepted, was that the manufacturers were “forced” to do so because of BRU’s market power in the retailing of baby products. But that is hardly plausible. Each of the products on which BRU sought RPM is, or easily could be, sold by discount retailers like Walmart, Target, and Kmart. While there are currently fewer than 270 Babies-R-Us stores in the United States, Walmart alone boasts 4,300 domestic outlets. The claim that BRU’s allegedly put-upon manufacturers would be unable to get their products to consumers absent BRU’s cooperation is simply incredible.

A far more plausible theory is that the manufacturers at issue gave in to BRU’s demands because they wanted their products to bear the prestige that comes from being sold at a trendy Babies-R-Us store. That “prestige stamp” is a service that BRU provides — a service that is conferred at considerable expense and that can be easily appropriated by low-cost dealers like Internet retailers.

It thus makes perfect sense that BRU would try to protect itself from no-frills dealers seeking to free-ride off its costly prestige stamp and that the manufacturers at issue would give in to BRU’s demands, expecting that the value-increase in their products resulting from the BRU prestige stamp would offset the higher price occasioned by the requested RPM and would enhance total output. This output-enhancing theory is significantly more plausible than the competing theory that the manufacturers were forced to give into a relatively small retail chain’s demands because of its market power in retailing.

If the FTC does decide to bring its own case against BRU, it will probably advocate the same “illegal if retailer-initiated” rule it set forth in its Nine West order. Judicial adoption of such a rule would be unfortunate. The identity of RPM’s instigator (retailer or manufacturer) says nothing about the RPM’s dominant rationale (to facilitate retailer collusion or to protect manufacturer and retailer interests in avoiding free-riding), and the fact that an instance of RPM was retailer-initiated by no means suggests that it was imposed for an illicit purpose.

The FTC announced a complaint today challenging Fresenius Medical Care AG & Co.’s proposed acquisition of an exclusive sublicense from Luitpold Pharmaceuticals, who is in turn a wholly owned subsidiary of a Japanese firm Daiichi Sankyo Company. The sublicense would allow Fresenius to manufacturer and supply the intravenous iron drug Venofer to dialysis clinics in the US. Here’s how the FTC press release describes the complaint:

The FTC’s complaint charges that the proposed vertical agreement would provide Fresenius, the largest provider of end-stage renal disease (ESRD) dialysis services in the United States, with the ability to increase Medicare reimbursement payments for Venofer. This is possible because after the transaction, the competitive market will no longer determine the price that Fresenius’ clinics will pay for intravenous (IV) iron. That amount will instead become an internal transfer price reported by Fresenius to the Center for Medicare & Medicaid Services (CMS).

Here’s where things get interesting:

The Commission’s consent order settling the complaint resolves the anticompetitive issues raised by the proposed transaction by preventing Fresenius from reporting an intra-company transfer price to CMS for Venofer that is higher than the level set forth in the order. The level in the order is derived from current market prices. The order further provides that if a generic Venofer product enters the market, Fresenius would be required to report its intra-company transfer price at the lower of the level set forth in the order or the lowest price at which Fresenius sells Venofer to any customer until December 31, 2011. These provisions are designed to ensure that the price Fresenius reports to CMS is in line with current market conditions, including potential generic entry. The order also provides that if CMS implements regulations that eliminate the potential anticompetitive harm from this transaction, those regulations will supersede the order.

Holding aside the underlying merits of the complaint, which I don’t know anything about, this strikes me as an unusual and highly regulatory remedy in that it includes both a price cap and a most-favored-nations (MFN) clause. How unusual is this? The criticism for imposing price controls are well known and don’t need to be rehearsed here. It should also be noted that the FTC itself has challenged MFN clauses in other settings!