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In a new article in the June 2008 issue of Antitrust Source, Howard Marvel discusses what the rule of reason could and should look like in the Post-Leegin world as well as the different proposals to a rule of reason approach articulated by the states and the FTC in the recent Nine West consent order modification. For interested readers, Marvel is much more generous to the FTC decision than co-blogger Thom who not to long ago posted a harsh (and in my view, fairly devastating on both legal and economic grounds) critique of the Commission’s approach.

As interesting as the issue of identifying the appropriate post-Leegin rule of reason RPM framework is, I want to focus instead on an interesting historical and analytical point Professor Marvel makes about the intellectual foundations of the Leegin decision and its approach to the law and economics of vertical restraints:

The antitrust treatment of non-price vertical restraints is a much compressed mirror of that of vertical price restraints. In 1963, no broad condemnation of non-price restraints was deemed appropriate because “too little was known about the competitive impact of such vertical limitations to warrant treating them as per se unlawful.” Apparently, however, this perceived lack of knowledge did not extend to those teaching or trained at Harvard. Within four years, the Court faced a similar challenge to exclusive territories in Schwinn and responded with a per se rule against the practice. The arguments for imposition of per se status came from impeccable sources—the Assistant Attorney General for Antitrust, Donald Turner, supported a brief written by a young Harvard-trained lawyer in the Solicitor General’s office, one Richard A. Posner. The Court thus was encouraged to endorse “then prevailing thinking of the economics profession [to bear] on restricted distribution.”

Posner, benefiting from remedial training at the University of Chicago, soon came to see the errors of the Harvard view, flaws well summarized by Oliver Williamson: Alas, what Turner and Posner took to be the then prevailing thinking of the economics profession was deeply confused. . . . [T]he prevailing thinking was self-limiting in three respects: (1) there was little appreciation for the possibility that product differentiation (as opposed to homogeneous product market exchange) might be the source of economic benefits, (2) there was even less appreciation for the possibility that the integrity of a distribution system could be compromised by subgoal pursuit among the parts (in this case, the individual franchisees), and (3) there was a preference for internal organization (hierarchy) over market organization (interfirm contract) if vertical restrictions, for whatever reason, were to be applied.

Marvel’s analysis supports my view that Leegin is perhaps the best example of the Roberts Court adopting a Chicagoan view of antitrust analysis (and not adopting the Harvard School view, contra Professor Elhauge). Along those lines, I’ve recently posted to SSRN a paper forthcoming in the Elgar Companion to Transaction Cost Economics further exploring the link between the The Chicago School, Transaction Cost Economics, and the Roberts Court’s Antitrust Jurisprudence.

In April 2000, the FTC issued a Complaint against women’s shoe distributor Nine West, claiming that Nine West had engaged in minimum resale price maintenance (RPM) (i.e., the setting of minimum prices that retailers could charge for its shoes). Apparently, Nine West was providing retailers with lists of “off limits” or “non-promote” shoes that weren’t to be promoted except during defined periods. Because Nine West sought acquiescence in those policies by threatening to terminate offending dealers, the FTC maintained that it had engaged in a minimum RPM agreement. At that time, such agreements were deemed to be per se unreasonable–and thus automatically illegal–restraints of trade. Nine West ultimately agreed to a broadly worded Consent Order requiring it to refrain from (among other things) fixing prices at which its retailers may sell, advertise, or promote its products; “otherwise pressuring” its dealers to adhere to resale prices; and “[s]ecuring or attempting to secure any commitment or assurance from any dealer concerning the resale price at which the dealer may advertise, promote, offer for sale or sell any Nine West Products.”

In last summer’s Leegin decision, the Supreme Court overruled Dr. Miles, the 1911 decision that had declared RPM agreements per se illegal. The Court reasoned that such agreements are frequently procompetitive and should not be condemned unless they are shown to violate the Rule of Reason (a fairly fact-intensive balancing test that considers the likely competitive effects of a restraint of trade in light of market structure so as to determine whether the restraint is, on balance, pro- or anti-competitive). In light of Leegin, which clearly undermined both the FTC’s Complaint against Nine West and its Consent Order, Nine West petitioned for modification of the Order to eliminate the prohibitions discussed above. Nine West reasoned that the Order unfairly placed it at a competitive disadvantage since its rivals now may engage in RPM and their RPM agreements cannot be successfully challenged absent a showing of actual competitive harm.

This all makes sense. The FTC’s Complaint and Order were based on an old (and much maligned) precedent holding that all minimum RPM agreements are automatically unreasonable and illegal. That precedent has been squarely overruled. Ergo, the Order should be revised to permit Nine West to engage in a business practice the Supreme Court has (correctly) concluded is usually pro-competitive. Seems pretty open and shut, right?

Think again. In an eighteen-page opinion released Tuesday (May 6), the FTC only partially granted Nine West’s request for modification and required Nine West to justify its use of RPM to the Commissioners by filing regular reports showing that its use of the practice is, in fact, pro-competitive.

Now one might wonder how a Supreme Court decision holding that minimum RPM is not presumptively unreasonable could support an order requiring Nine West to continually justify (i.e., to prove the reasonableness of) its use of the practice. Indeed, wasn’t the point of Leegin to put the burden of establishing the unreasonableness of any instance of RPM on the party complaining about the practice? The FTC says no. It maintains that the Rule of Reason applicable to RPM should presume that any instance of the practice is anti-competitive unless the defendant makes some showing otherwise.

To reach this rather odd conclusion, the FTC latches on to the Leegin Court’s observation that:

[a]s courts gain experience considering the effects of these restraints by applying the rule of reason over the course of decisions, they can establish the litigation structure to ensure that the rule operates to eliminate anticompetitive restraints from the market and to provide more guidance to businesses. Courts can, for example, devise rules over time for offering proof, or even presumptions where justified, to make the rule of reason a fair and efficient way to prohibit anticompetitive restraints and to promote competitive ones.

By this remark, the FTC contends, the Supreme Court directed the lower courts and regulatory agencies to adopt “the analytical approach that the D.C. Circuit endorsed in Polygram Holdings” [a.k.a. the “Three Tenors” case]. Under that approach, which builds on the “quick look” or truncated Rule of Reason the Supreme Court began to apply in 1978 in the Professional Engineers case, an antitrust tribunal considering a practice that is “inherently suspect,” though not per se illegal, may presume the practice unreasonable unless the defendant “either identif[ies] some reason the restraint is unlikely to harm consumers, or identif[ies] some competitive benefit that plausibly offsets the apparent or anticipated harm.” Minimum RPM, the FTC argues, is “inherently suspect” because it bears a “close family resemblance” to “‘another practice that already stands convicted in the court of consumer welfare’ – horizontal price-fixing.” Thus, the FTC concludes, Leegin, properly interpreted, presumes the unreasonableness of minimum RPM unless the defendant establishes that anticompetitive harm is unlikely by showing, for example, that the manufacturer engaging in RPM lacks market power, that the impetus for the RPM arrangement is the manufacturer rather than its retailers, and that there is no dominant retailer that might be responsible for the RPM agreement. While Nine West made such a showing (which is why the FTC begrudgingly agreed to modify the order so as to permit RPM), “the circumstances in the market could change” (which is why the Commission required Nine West to continually justify its use of the practice).

This is hogwash.

As an initial matter, the quoted remark from Leegin contemplates a structured Rule of Reason, not the sort of truncated inquiry approved in Professional Engineers and its progeny. The Court was simply saying that as courts accumulate experience evaluating minimum RPM, they will be able to articulate the precise factors that should be considered in determining the legality of any particular instance. Courts have done this sort of thing with other practices that are subject to the Rule of Reason. Horizontal data exchanges, for example, are evaluated by considering specific aspects of the structure of the market in which the participants compete and the nature of the information exchange (see Todd v. Exxon). The Rule of Reason applicable to exclusive dealing practices involves a structured “qualitative foreclosure” inquiry (see Tampa Electric). As courts gain experience with minimum RPM, they will similarly set forth a structured inquiry that is both easier to apply and more predictable than the “kitchen sink” Rule of Reason first set forth by Justice Brandeis in the Chicago Board of Trade decision.

In addition, the FTC erred in concluding that minimum RPM is “inherently suspect” and thus presumptively unreasonable. The Polygram Holdings (Three Tenors) decision itself sets forth the standard for inherently suspect, but not per se illegal, restraints:

If, based upon economic learning and the experience of the market, it is obvious that a restraint of trade likely impairs competition, then the restraint of trade is presumed unlawful and, in order to avoid liability, the defendant must either identify some reason the restraint is unlikely to harm consumers or identify some competitive benefit that plausibly offsets the apparent or anticipated harm.

It is simply not the case that “economic learning” and “the experience of the market” have made it “obvious” that minimum RPM “likely impairs competition.” The Leegin Court was crystal clear on that point.

Presumably realizing as much, the FTC latches onto another statement from Polygram Holdings – the observation that a restraint may be inherently suspicious because of “the close family resemblance between the suspect practice and another practice that already stands convicted in the court of consumer welfare.” The Commission maintains that vertical RPM bears that sort of resemblance to horizontal price-fixing.

But that’s just crazy. While horizontal and vertical price-fixing (minimum RPM) both involve the fixing of prices, there are hugely important differences between the two practices. Most notably, minimum RPM usually cannot benefit the price-fixer (the manufacturer) unless it increases sales at the retail level, generally by motivating point-of-sale services that make the product at issue more desirable to consumers. By contrast, horizontal price-fixing benefits the price-fixers by decreasing output to consumers. Thus, saying that the two practices bear a close family resemblance because they both involve price-fixing is like saying that Gary Coleman and Heidi Klum resemble each other because they both have legs.

As we’ve previously explained (and as the FTC well knows), it’s really hard to use RPM to accomplish anti-competitive ends. Pro-competitive rationales undoubtedly explain most instances of minimum RPM, and for that reason, the burden should be on the party challenging an RPM practice to prove his less plausible story.

The FTC’s May 6 opinion seems to be coated with the fingerprints of Commissioner Pamela Jones Harbour, who has made no secret of her affection for Dr. Miles. At this point, though, it’s getting a little embarrassing. While we all know how hard it can be to say goodbye, it’s time to let the Good Doctor go.