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The American Choice and Innovation Online Act (previously called the Platform Anti-Monopoly Act), introduced earlier this summer by U.S. Rep. David Cicilline (D-R.I.), would significantly change the nature of digital platforms and, with them, the internet itself. Taken together, the bill’s provisions would turn platforms into passive intermediaries, undermining many of the features that make them valuable to consumers. This seems likely to remain the case even after potential revisions intended to minimize the bill’s unintended consequences.

In its current form, the bill is split into two parts that each is dangerous in its own right. The first, Section 2(a), would prohibit almost any kind of “discrimination” by platforms. Because it is so open-ended, lawmakers might end up removing it in favor of the nominally more focused provisions of Section 2(b), which prohibit certain named conduct. But despite being more specific, this section of the bill is incredibly far-reaching and would effectively ban swaths of essential services.

I will address the potential effects of these sections point-by-point, but both elements of the bill suffer from the same problem: a misguided assumption that “discrimination” by platforms is necessarily bad from a competition and consumer welfare point of view. On the contrary, this conduct is often exactly what consumers want from platforms, since it helps to bring order and legibility to otherwise-unwieldy parts of the Internet. Prohibiting it, as both main parts of the bill do, would make the Internet harder to use and less competitive.

Section 2(a)

Section 2(a) essentially prohibits any behavior by a covered platform that would advantage that platform’s services over any others that also uses that platform; it characterizes this preferencing as “discrimination.”

As we wrote when the House Judiciary Committee’s antitrust bills were first announced, this prohibition on “discrimination” is so broad that, if it made it into law, it would prevent platforms from excluding or disadvantaging any product of another business that uses the platform or advantaging their own products over those of their competitors.

The underlying assumption here is that platforms should be like telephone networks: providing a way for different sides of a market to communicate with each other, but doing little more than that. When platforms do do more—for example, manipulating search results to favor certain businesses or to give their own products prominence —it is seen as exploitative “leveraging.”

But consumers often want platforms to be more than just a telephone network or directory, because digital markets would be very difficult to navigate without some degree of “discrimination” between sellers. The Internet is so vast and sellers are often so anonymous that any assistance which helps you choose among options can serve to make it more navigable. As John Gruber put it:

From what I’ve seen over the last few decades, the quality of the user experience of every computing platform is directly correlated to the amount of control exerted by its platform owner. The current state of the ownerless world wide web speaks for itself.

Sometimes, this manifests itself as “self-preferencing” of another service, to reduce additional time spent searching for the information you want. When you search for a restaurant on Google, it can be very useful to get information like user reviews, the restaurant’s phone number, a button on mobile to phone them directly, estimates of how busy it is, and a link to a Maps page to see how to actually get there.

This is, undoubtedly, frustrating for competitors like Yelp, who would like this information not to be there and for users to have to click on either a link to Yelp or a link to Google Maps. But whether it is good or bad for Yelp isn’t relevant to whether it is good for users—and it is at least arguable that it is, which makes a blanket prohibition on this kind of behavior almost inevitably harmful.

If it isn’t obvious why removing this kind of feature would be harmful for users, ask yourself why some users search in Yelp’s app directly for this kind of result. The answer, I think, is that Yelp gives you all the information above that Google does (and sometimes is better, although I tend to trust Google Maps’ reviews over Yelp’s), and it’s really convenient to have all that on the same page. If Google could not provide this kind of “rich” result, many users would probably stop using Google Search to look for restaurant information in the first place, because a new friction would have been added that made the experience meaningfully worse. Removing that option would be good for Yelp, but mainly because it removes a competitor.

If all this feels like stating the obvious, then it should highlight a significant problem with Section 2(a) in the Cicilline bill: it prohibits conduct that is directly value-adding for consumers, and that creates competition for dedicated services like Yelp that object to having to compete with this kind of conduct.

This is true across all the platforms the legislation proposes to regulate. Amazon prioritizes some third-party products over others on the basis of user reviews, rates of returns and complaints, and so on; Amazon provides private label products to fill gaps in certain product lines where existing offerings are expensive or unreliable; Apple pre-installs a Camera app on the iPhone that, obviously, enjoys an advantage over rival apps like Halide.

Some or all of this behavior would be prohibited under Section 2(a) of the Cicilline bill. Combined with the bill’s presumption that conduct must be defended affirmatively—that is, the platform is presumed guilty unless it can prove that the challenged conduct is pro-competitive, which may be very difficult to do—and the bill could prospectively eliminate a huge range of socially valuable behavior.

Supporters of the bill have already been left arguing that the law simply wouldn’t be enforced in these cases of benign discrimination. But this would hardly be an improvement. It would mean the Federal Trade Commission (FTC) and U.S. Justice Department (DOJ) have tremendous control over how these platforms are built, since they could challenge conduct in virtually any case. The regulatory uncertainty alone would complicate the calculus for these firms as they refine, develop, and deploy new products and capabilities. 

So one potential compromise might be to do away with this broad-based rule and proscribe specific kinds of “discriminatory” conduct instead. This approach would involve removing Section 2(a) from the bill but retaining Section 2(b), which enumerates 10 practices it deems to be “other discriminatory conduct.” This may seem appealing, as it would potentially avoid the worst abuses of the broad-based prohibition. In practice, however, it would carry many of the same problems. In fact, many of 2(b)’s provisions appear to go even further than 2(a), and would proscribe even more procompetitive conduct that consumers want.

Sections 2(b)(1) and 2(b)(9)

The wording of these provisions is extremely broad and, as drafted, would seem to challenge even the existence of vertically integrated products. As such, these prohibitions are potentially even more extensive and invasive than Section 2(a) would have been. Even a narrower reading here would seem to preclude safety and privacy features that are valuable to many users. iOS’s sandboxing of apps, for example, serves to limit the damage that a malware app can do on a user’s device precisely because of the limitations it imposes on what other features and hardware the app can access.

Section 2(b)(2)

This provision would preclude a firm from conditioning preferred status on use of another service from that firm. This would likely undermine the purpose of platforms, which is to absorb and counter some of the risks involved in doing business online. An example of this is Amazon’s tying eligibility for its Prime program to sellers that use Amazon’s delivery service (FBA – Fulfilled By Amazon). The bill seems to presume in an example like this that Amazon is leveraging its power in the market—in the form of the value of the Prime label—to profit from delivery. But Amazon could, and already does, charge directly for listing positions; it’s unclear why it would benefit from charging via FBA when it could just charge for the Prime label.

An alternate, simpler explanation is that FBA improves the quality of the service, by granting customers greater assurance that a Prime product will arrive when Amazon says it will. Platforms add value by setting out rules and providing services that reduce the uncertainties between buyers and sellers they’d otherwise experience if they transacted directly with each other. This section’s prohibition—which, as written, would seem to prevent any kind of quality assurance—likely would bar labelling by a platform, even where customers explicitly want it.

Section 2(b)(3)

As written, this would prohibit platforms from using aggregated data to improve their services at all. If Apple found that 99% of its users uninstalled an app immediately after it was installed, it would be reasonable to conclude that the app may be harmful or broken in some way, and that Apple should investigate. This provision would ban that.

Sections 2(b)(4) and 2(b)(6)

These two provisions effectively prohibit a platform from using information it does not also provide to sellers. Such prohibitions ignore the fact that it is often good for sellers to lack certain information, since withholding information can prevent abuse by malicious users. For example, a seller may sometimes try to bribe their customers to post positive reviews of their products, or even threaten customers who have posted negative ones. Part of the role of a platform is to combat that kind of behavior by acting as a middleman and forcing both consumer users and business users to comply with the platform’s own mechanisms to control that kind of behavior.

If this seems overly generous to platforms—since, obviously, it gives them a lot of leverage over business users—ask yourself why people use platforms at all. It is not a coincidence that people often prefer Amazon to dealing with third-party merchants and having to navigate those merchants’ sites themselves. The assurance that Amazon provides is extremely valuable for users. Much of it comes from the company’s ability to act as a middleman in this way, lowering the transaction costs between buyers and sellers.

Section 2(b)(5)

This provision restricts the treatment of defaults. It is, however, relatively restrained when compared to, for example, the DOJ’s lawsuit against Google, which treats as anticompetitive even payment for defaults that can be changed. Still, many of the arguments that apply in that case also apply here: default status for apps can be a way to recoup income foregone elsewhere (e.g., a browser provided for free that makes its money by selling the right to be the default search engine).

Section 2(b)(7)

This section gets to the heart of why “discrimination” can often be procompetitive: that it facilitates competition between platforms. The kind of self-preferencing that this provision would prohibit can allow firms that have a presence in one market to extend that position into another, increasing competition in the process. Both Apple and Amazon have used their customer bases in smartphones and e-commerce, respectively, to grow their customer bases for video streaming, in competition with Netflix, Google’s YouTube, cable television, and each other. If Apple designed a search engine to compete with Google, it would do exactly the same thing, and we would be better off because of it. Restricting this kind of behavior is, perversely, exactly what you would do if you wanted to shield these incumbents from competition.

Section 2(b)(8)

As with other provisions, this one would preclude one of the mechanisms by which platforms add value: creating assurance for customers about the products they can expect if they visit the platform. Some of this relates to child protection; some of the most frustrating stories involve children being overcharged when they use an iPhone or Android app, and effectively being ripped off because of poor policing of the app (or insufficiently strict pricing rules by Apple or Google). This may also relate to rules that state that the seller cannot offer a cheaper product elsewhere (Amazon’s “General Pricing Rule” does this, for example). Prohibiting this would simply impose a tax on customers who cannot shop around and would prefer to use a platform that they trust has the lowest prices for the item they want.

Section 2(b)(10)

Ostensibly a “whistleblower” provision, this section could leave platforms with no recourse, not even removing a user from its platform, in response to spurious complaints intended purely to extract value for the complaining business rather than to promote competition. On its own, this sort of provision may be fairly harmless, but combined with the provisions above, it allows the bill to add up to a rent-seekers’ charter.

Conclusion

In each case above, it’s vital to remember that a reversed burden of proof applies. So, there is a high chance that the law will side against the defendant business, and a large downside for conduct that ends up being found to violate these provisions. That means that platforms will likely err on the side of caution in many cases, avoiding conduct that is ambiguous, and society will probably lose a lot of beneficial behavior in the process.

Put together, the provisions undermine much of what has become an Internet platform’s role: to act as an intermediary, de-risk transactions between customers and merchants who don’t know each other, and tweak the rules of the market to maximize its attractiveness as a place to do business. The “discrimination” that the bill would outlaw is, in practice, behavior that makes it easier for consumers to navigate marketplaces of extreme complexity and uncertainty, in which they often know little or nothing about the firms with whom they are trying to transact business.

Customers do not want platforms to be neutral, open utilities. They can choose platforms that are like that already, such as eBay. They generally tend to prefer ones like Amazon, which are not neutral and which carefully cultivate their service to be as streamlined, managed, and “discriminatory” as possible. Indeed, many of people’s biggest complaints with digital platforms relate to their openness: the fake reviews, counterfeit products, malware, and spam that come with letting more unknown businesses use your service. While these may be unavoidable by-products of running a platform, platforms compete on their ability to ferret them out. Customers are unlikely to thank legislators for regulating Amazon into being another eBay.

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

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

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

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

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

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

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

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

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

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

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

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

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

Rescission of the Unfair Methods of Competition Policy Statement

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

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

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

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

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

New Guidance to Parties Considering Mergers

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

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

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

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

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

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

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

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

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

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

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

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

Proposed FTC Competition Rulemakings

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

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

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

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

Conclusion

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

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

The U.S. House this week passed H.R. 2668, the Consumer Protection and Recovery Act (CPRA), which authorizes the Federal Trade Commission (FTC) to seek monetary relief in federal courts for injunctions brought under Section 13(b) of the Federal Trade Commission Act.

Potential relief under the CPRA is comprehensive. It includes “restitution for losses, rescission or reformation of contracts, refund of money, return of property … and disgorgement of any unjust enrichment that a person, partnership, or corporation obtained as a result of the violation that gives rise to the suit.” What’s more, under the CPRA, monetary relief may be obtained for violations that occurred up to 10 years before the filing of the suit in which relief is requested by the FTC.

The Senate should reject the House version of the CPRA. Its monetary-recovery provisions require substantial narrowing if it is to pass cost-benefit muster.

The CPRA is a response to the Supreme Court’s April 22 decision in AMG Capital Management v. FTC, which held that Section 13(b) of the FTC Act does not authorize the commission to obtain court-ordered equitable monetary relief. As I explained in an April 22 Truth on the Market post, Congress’ response to the court’s holding should not be to grant the FTC carte blanche authority to obtain broad monetary exactions for any and all FTC Act violations. I argued that “[i]f Congress adopts a cost-beneficial error-cost framework in shaping targeted legislation, it should limit FTC monetary relief authority (recoupment and disgorgement) to situations of consumer fraud or dishonesty arising under the FTC’s authority to pursue unfair or deceptive acts or practices.”

Error cost and difficulties of calculation counsel against pursuing monetary recovery in FTC unfair methods of competition cases. As I explained in my post:

Consumer redress actions are problematic for a large proportion of FTC antitrust enforcement (“unfair methods of competition”) initiatives. Many of these antitrust cases are “cutting edge” matters involving novel theories and complex fact patterns that pose a significant threat of type I [false positives] error. (In comparison, type I error is low in hardcore collusion cases brought by the U.S. Justice Department where the existence, nature, and effects of cartel activity are plain). What’s more, they generally raise extremely difficult if not impossible problems in estimating the degree of consumer harm. (Even DOJ price-fixing cases raise non-trivial measurement difficulties.)

These error-cost and calculation difficulties became even more pronounced as of July 1. On that date, the FTC unwisely voted 3-2 to withdraw a bipartisan 2015 policy statement providing that the commission would apply consumer welfare and rule-of-reason (weighing efficiencies against anticompetitive harm) considerations in exercising its unfair methods of competition authority (see my commentary here). This means that, going forward, the FTC will arrogate to itself unbounded discretion to decide what competitive practices are “unfair.” Business uncertainty, and the costly risk aversion it engenders, would be expected to grow enormously if the FTC could extract monies from firms due to competitive behavior deemed “unfair,” based on no discernible neutral principle.

Error costs and calculation problems also strongly suggest that monetary relief in FTC consumer-protection matters should be limited to cases of fraud or clear deception. As I noted:

[M]atters involving a higher likelihood of error and severe measurement problems should be the weakest candidates for consumer redress in the consumer protection sphere. For example, cases involve allegedly misleading advertising regarding the nature of goods, or allegedly insufficient advertising substantiation, may generate high false positives and intractable difficulties in estimating consumer harm. As a matter of judgment, given resource constraints, seeking financial recoveries solely in cases of fraud or clear deception where consumer losses are apparent and readily measurable makes the most sense from a cost-benefit perspective.

In short, the Senate should rewrite its Section 13(b) amendments to authorize FTC monetary recoveries only when consumer fraud and dishonesty is shown.

Finally, the Senate would be wise to sharply pare back the House language that allows the FTC to seek monetary exactions based on conduct that is a decade old. Serious problems of making accurate factual determinations of economic effects and specific-damage calculations would arise after such a long period of time. Allowing retroactive determinations based on a shorter “look-back” period prior to the filing of a complaint (three years, perhaps) would appear to strike a better balance in allowing reasonable redress while controlling error costs.

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

The Risks of Antitrust by Anecdote

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

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

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

The Specter of No-Fault Antitrust Liability

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

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

Remembering Why Market Power Matters

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

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

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

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

The U.S. Supreme Court’s just-published unanimous decision in AMG Capital Management LLC v. FTC—holding that Section 13(b) of the Federal Trade Commission Act does not authorize the commission to obtain court-ordered equitable monetary relief (such as restitution or disgorgement)—is not surprising. Moreover, by dissipating the cloud of litigation uncertainty that has surrounded the FTC’s recent efforts to seek such relief, the court cleared the way for consideration of targeted congressional legislation to address the issue.

But what should such legislation provide? After briefly summarizing the court’s holding, I will turn to the appropriate standards for optimal FTC consumer redress actions, which inform a welfare-enhancing legislative fix.

The Court’s Opinion

Justice Stephen Breyer’s opinion for the court is straightforward, centering on the structure and history of the FTC Act. Section 13(b) makes no direct reference to monetary relief. Its plain language merely authorizes the FTC to seek a “permanent injunction” in federal court against “any person, partnership, or corporation” that it believes “is violating, or is about to violate, any provision of law” that the commission enforces. In addition, by its terms, Section 13(b) is forward-looking, focusing on relief that is prospective, not retrospective (this cuts against the argument that payments for prior harm may be recouped from wrongdoers).

Furthermore, the FTC Act provisions that specifically authorize conditioned and limited forms of monetary relief (Section 5(l) and Section 19) are in the context of commission cease and desist orders, involving FTC administrative proceedings, unlike Section 13(b) actions that avoid the administrative route. In sum, the court concludes that:

[T]o read §13(b) to mean what it says, as authorizing injunctive but not monetary relief, produces a coherent enforcement scheme: The Commission may obtain monetary relief by first invoking its administrative procedures and then §19’s redress provisions (which include limitations). And the Commission may use §13(b) to obtain injunctive relief while administrative proceedings are foreseen or in progress, or when it seeks only injunctive relief. By contrast, the Commission’s broad reading would allow it to use §13(b) as a substitute for §5 and §19. For the reasons we have just stated, that could not have been Congress’ intent.

The court’s opinion concludes by succinctly rejecting the FTC’s arguments to the contrary.

What Comes Next

The Supreme Court’s decision has been anticipated by informed observers. All four sitting FTC Commissioners have already called for a Section 13(b) “legislative fix,” and in an April 20 hearing of Senate Commerce Committee, Chairwoman Maria Cantwell (D-Wash.) emphasized that, “[w]e have to do everything we can to protect this authority and, if necessary, pass new legislation to do so.”

What, however, should be the contours of such legislation? In considering alternative statutory rules, legislators should keep in mind not only the possible consumer benefits of monetary relief, but the costs of error, as well. Error costs are a ubiquitous element of public law enforcement, and this is particularly true in the case of FTC actions. Ideally, enforcers should seek to minimize the sum of the costs attributable to false positives (type I error), false negatives (type II error), administrative costs, and disincentive costs imposed on third parties, which may also be viewed as a subset of false positives. (See my 2014 piece “A Cost-Benefit Framework for Antitrust Enforcement Policy.”

Monetary relief is most appropriate in cases where error costs are minimal, and the quantum of harm is relatively easy to measure. This suggests a spectrum of FTC enforcement actions that may be candidates for monetary relief. Ideally, selection of targets for FTC consumer redress actions should be calibrated to yield the highest return to scarce enforcement resources, with an eye to optimal enforcement criteria.

Consider consumer protection enforcement. The strongest cases involve hardcore consumer fraud (where fraudulent purpose is clear and error is almost nil); they best satisfy accuracy in measurement and error-cost criteria. Next along the spectrum are cases of non-fraudulent but unfair or deceptive acts or practices that potentially involve some degree of error. In this category, situations involving easily measurable consumer losses (e.g., systematic failure to deliver particular goods requested or poor quality control yielding shipments of ruined goods) would appear to be the best candidates for monetary relief.

Moving along the spectrum, matters involving a higher likelihood of error and severe measurement problems should be the weakest candidates for consumer redress in the consumer protection sphere. For example, cases involve allegedly misleading advertising regarding the nature of goods, or allegedly insufficient advertising substantiation, may generate high false positives and intractable difficulties in estimating consumer harm. As a matter of judgment, given resource constraints, seeking financial recoveries solely in cases of fraud or clear deception where consumer losses are apparent and readily measurable makes the most sense from a cost-benefit perspective.

Consumer redress actions are problematic for a large proportion of FTC antitrust enforcement (“unfair methods of competition”) initiatives. Many of these antitrust cases are “cutting edge” matters involving novel theories and complex fact patterns that pose a significant threat of type I error. (In comparison, type I error is low in hardcore collusion cases brought by the U.S. Justice Department where the existence, nature, and effects of cartel activity are plain). What’s more, they generally raise extremely difficult if not impossible problems in estimating the degree of consumer harm. (Even DOJ price-fixing cases raise non-trivial measurement difficulties.)

For example, consider assigning a consumer welfare loss number to a patent antitrust settlement that may or may not have delayed entry of a generic drug by some length of time (depending upon the strength of the patent) or to a decision by a drug company to modify a drug slightly just before patent expiration in order to obtain a new patent period (raising questions of valuing potential product improvements). These and other examples suggest that only rarely should the FTC pursue requests for disgorgement or restitution in antitrust cases, if error-cost-centric enforcement criteria are to be honored.

Unfortunately, the FTC currently has nothing to say about when it will seek monetary relief in antitrust matters. Commendably, in 2003, the commission issued a Policy Statement on Monetary Equitable Remedies in Competition Cases specifying that it would only seek monetary relief in “exceptional cases” involving a “[c]lear [v]iolation” of the antitrust laws. Regrettably, in 2012, a majority of the FTC (with Commissioner Maureen Ohlhausen dissenting) withdrew that policy statement and the limitations it imposed. As I concluded in a 2012 article:

This action, which was taken without the benefit of advance notice and public comment, raises troubling questions. By increasing business uncertainty, the withdrawal may substantially chill efficient business practices that are not well understood by enforcers. In addition, it raises the specter of substantial error costs in the FTC’s pursuit of monetary sanctions. In short, it appears to represent a move away from, rather than towards, an economically enlightened antitrust enforcement policy.

In a 2013 speech, then-FTC Commissioner Josh Wright also lamented the withdrawal of the 2003 Statement, and stated that he would limit:

… the FTC’s ability to pursue disgorgement only against naked price fixing agreements among competitors or, in the case of single firm conduct, only if the monopolist’s conduct has no plausible efficiency justification. This latter category would include fraudulent or deceptive conduct, or tortious activity such as burning down a competitor’s plant.

As a practical matter, the FTC does not bring cases of this sort. The DOJ brings naked price-fixing cases and the unilateral conduct cases noted are as scarce as unicorns. Given that fact, Wright’s recommendation may rightly be seen as a rejection of monetary relief in FTC antitrust cases. Based on the previously discussed serious error-cost and measurement problems associated with monetary remedies in FTC antitrust cases, one may also conclude that the Wright approach is right on the money.

Finally, a recent article by former FTC Chairman Tim Muris, Howard Beales, and Benjamin Mundel opined that Section 13(b) should be construed to “limit[] the FTC’s ability to obtain monetary relief to conduct that a reasonable person would know was dishonest or fraudulent.” Although such a statutory reading is now precluded by the Supreme Court’s decision, its incorporation in a new statutory “fix” would appear ideal. It would allow for consumer redress in appropriate cases, while avoiding the likely net welfare losses arising from a more expansive approach to monetary remedies.

 Conclusion

The AMG Capital decision is sure to generate legislative proposals to restore the FTC’s ability to secure monetary relief in federal court. If Congress adopts a cost-beneficial error-cost framework in shaping targeted legislation, it should limit FTC monetary relief authority (recoupment and disgorgement) to situations of consumer fraud or dishonesty arising under the FTC’s authority to pursue unfair or deceptive acts or practices. Giving the FTC carte blanche to obtain financial recoveries in the full spectrum of antitrust and consumer protection cases would spawn uncertainty and could chill a great deal of innovative business behavior, to the ultimate detriment of consumer welfare.


,

In a constructive development, the Federal Trade Commission has joined its British counterpart in investigating Nvidia’s proposed $40 billion acquisition of chip designer Arm, a subsidiary of Softbank. Arm provides the technological blueprints for wireless communications devices and, subject to a royalty fee, makes those crown-jewel assets available to all interested firms. Notwithstanding Nvidia’s stated commitment to keep the existing policy in place, there is an obvious risk that the new parent, one of the world’s leading chip makers, would at some time modify this policy with adverse competitive effects.

Ironically, the FTC is likely part of the reason that the Nvidia-Arm transaction is taking place.

Since the mid-2000s, the FTC and other leading competition regulators (except for the U.S. Department of Justice’s Antitrust Division under the leadership of former Assistant Attorney General Makan Delrahim) have intervened extensively in licensing arrangements in wireless device markets, culminating in the FTC’s recent failed suit against Qualcomm. The Nvidia-Arm transaction suggests that these actions may simply lead chip designers to abandon the licensing model and shift toward structures that monetize chip-design R&D through integrated hardware and software ecosystems. Amazon and Apple are already undertaking chip innovation through this model. Antitrust action that accelerates this movement toward in-house chip design is likely to have adverse effects for the competitive health of the wireless ecosystem.

How IP Licensing Promotes Market Access

Since its inception, the wireless communications market has relied on a handful of IP licensors to supply device producers and other intermediate users with a common suite of technology inputs. The result has been an efficient division of labor between firms that specialize in upstream innovation and firms that specialize in production and other downstream functions. Contrary to the standard assumption that IP rights limit access, this licensing-based model ensures technology access to any firm willing to pay the royalty fee.

Efforts by regulators to reengineer existing relationships between innovators and implementers endanger this market structure by inducing innovators to abandon licensing-based business models, which now operate under a cloud of legal insecurity, for integrated business models in which returns on R&D investments are captured internally through hardware and software products. Rather than expanding technology access and intensifying competition, antitrust restraints on licensing freedom are liable to limit technology access and increase market concentration.

Regulatory Intervention and Market Distortion

This interventionist approach has relied on the assertion that innovators can “lock in” producers and extract a disproportionate fee in exchange for access. This prediction has never found support in fact. Contrary to theoretical arguments that patent owners can impose double-digit “royalty stacks” on device producers, empirical researchers have repeatedly found that the estimated range of aggregate rates lies in the single digits. These findings are unsurprising given market performance over more than two decades: adoption has accelerated as quality-adjusted prices have fallen and innovation has never ceased. If rates were exorbitant, market growth would have been slow, and the smartphone would be a luxury for the rich.

Despite these empirical infirmities, the FTC and other competition regulators have persisted in taking action to mitigate “holdup risk” through policy statements and enforcement actions designed to preclude IP licensors from seeking injunctive relief. The result is a one-sided legal environment in which the world’s largest device producers can effectively infringe patents at will, knowing that the worst-case scenario is a “reasonable royalty” award determined by a court, plus attorneys’ fees. Without any credible threat to deny access even after a favorable adjudication on the merits, any IP licensor’s ability to negotiate a royalty rate that reflects the value of its technology contribution is constrained.

Assuming no change in IP licensing policy on the horizon, it is therefore not surprising that an IP licensor would seek to shift toward an integrated business model in which IP is not licensed but embedded within an integrated suite of products and services. Or alternatively, an IP licensor entity might seek to be acquired by a firm that already has such a model in place. Hence, FTC v. Qualcomm leads Arm to Nvidia.

The Error Costs of Non-Evidence-Based Antitrust

These counterproductive effects of antitrust intervention demonstrate the error costs that arise when regulators act based on unverified assertions of impending market failure. Relying on the somewhat improbable assumption that chip suppliers can dictate licensing terms to device producers that are among the world’s largest companies, competition regulators have placed at risk the legal predicates of IP rights and enforceable contracts that have made the wireless-device market an economic success. As antitrust risk intensifies, the return on licensing strategies falls and competitive advantage shifts toward integrated firms that can monetize R&D internally through stand-alone product and service ecosystems.

Far from increasing competitiveness, regulators’ current approach toward IP licensing in wireless markets is likely to reduce it.

[TOTM: The following is part of a digital symposium by TOTM guests and authors on the legal and regulatory issues that arose during Ajit Pai’s tenure as chairman of the Federal Communications Commission. The entire series of posts is available here.

Kristian Stout is director of innovation policy for the International Center for Law & Economics.]

One of the themes that has run throughout this symposium has been that, throughout his tenure as both a commissioner and as chairman, Ajit Pai has brought consistency and careful analysis to the Federal Communications Commission (McDowell, Wright). The reflections offered by the various authors in this symposium make one thing clear: the next administration would do well to learn from the considered, bipartisan, and transparent approach to policy that characterized Chairman Pai’s tenure at the FCC.

The following are some of the more specific lessons that can be learned from Chairman Pai. In an important sense, he laid the groundwork for his successful chairmanship when he was still a minority commissioner. His thoughtful dissents were rooted in consistent, clear policy arguments—a practice that both charted how he would look at future issues as chairman and would help the public to understand exactly how he would approach new challenges before the FCC (McDowell, Wright).

One of the most public instances of Chairman Pai’s consistency (and, as it turns out, his bravery) was with respect to net neutrality. From his dissent in the Title II Order, through his commission’s Restoring Internet Freedom Order, Chairman Pai focused on the actual welfare of consumers and the factors that drive network growth and adoption. As Brent Skorup noted, “Chairman Pai and the Republican commissioners recognized the threat that Title II posed, not only to free speech, but to the FCC’s goals of expanding telecommunications services and competition.” The result of giving in to the Title II advocates would have been to draw the FCC into a quagmire of mass-media regulation that would ultimately harm free expression and broadband deployment in the United States.

Chairman Pai’s vision worked out (Skorup, May, Manne, Hazlett). Despite prognostications of the “death of the internet” because of the Restoring Internet Freedom Order, available evidence suggests that industry investment grew over Chairman Pai’s term. More Americans are connected to broadband than ever before.

Relatedly, Chairman Pai was a strong supporter of liberalizing media-ownership rules that long had been rooted in 20th century notions of competition (Manne). Such rules systematically make it harder for smaller media outlets to compete with large news aggregators and social-media platforms. As Geoffrey Manne notes: 

Consistent with his unwavering commitment to promote media competition… Chairman Pai put forward a proposal substantially updating the media-ownership rules to reflect the dramatically changed market realities facing traditional broadcasters and newspapers.

This was a bold move for Chairman Pai—in essence, he permitted more local concentration by, e.g., allowing the purchase of a newspaper by a local television station that previously would have been forbidden. By allowing such combinations, the FCC enabled failing local news outlets to shore up their losses and continue to compete against larger, better-resourced organizations. The rule changes are in a case pending before the Supreme Court; should the court find for the FCC, the competitive outlook for local media looks much better thanks to Chairman Pai’s vision.

Chairman Pai’s record on spectrum is likewise impressive (Cooper, Hazlett). The FCC’s auctions under Chairman Pai raised more money and freed more spectrum for higher value uses than any previous commission (Feld, Hazlett). But there is also a lesson in how subsequent administrations can continue what Chairman Pai started. Unlicensed use, for instance, is not free or costless in its maintenance, and Tom Hazlett believes that there is more work to be done in further liberalizing access to the related spectrum—liberalizing in the sense of allowing property rights and market processes to guide spectrum to its highest use:

The basic theme is that regulators do better when they seek to create new rights that enable social coordination and entrepreneurial innovation, rather than enacting rules that specify what they find to be the “best” technologies or business models.

And to a large extent this is the model that Chairman Pai set down, from the issuance of the 12 GHZ NPRM to consider whether those spectrum bands could be opened up for wireless use, to the L-Band Order, where the commission worked hard to reallocate spectrum rights in ways that would facilitate more productive uses.

The controversial L-Band Order was another example of where Chairman Pai displayed both political acumen as well as an apolitical focus on improving spectrum policy (Cooper). Political opposition was sharp and focused after the commission finalized its order in April 2020. Nonetheless, Chairman Pai was deftly able to shepherd the L-Band Order and guarantee that important spectrum was made available for commercial wireless use.

As a native of Kansas, rural broadband rollout ranked highly in the list of priorities at the Pai FCC, and his work over the last four years is demonstrative of this pride of place (Hurwitz, Wright). As Gus Hurwitz notes, “the commission completed the Connect America Fund Phase II Auction. More importantly, it initiated the Rural Digital Opportunity Fund (RDOF) and the 5G Fund for Rural America, both expressly targeting rural connectivity.”

Further, other work, like the recently completed Rural Digital Opportunity Fund auction and the 5G fund provide the necessary policy framework with which to extend greater connectivity to rural America. As Josh Wright notes, “Ajit has also made sure to keep an eye out for the little guy, and communities that have been historically left behind.” This focus on closing the digital divide yielded gains in connectivity in places outside of traditional rural American settings, such as tribal lands, the U.S. Virgin Islands, and Puerto Rico (Wright).

But perhaps one of Chairman Pai’s best and (hopefully) most lasting contributions will be de-politicizing the FCC and increasing the transparency with which it operated. In contrast to previous administrations, the Pai FCC had an overwhelmingly bipartisan nature, with many bipartisan votes being regularly taken at monthly meetings (Jamison). In important respects, it was this bipartisan (or nonpartisan) nature that was directly implicated by Chairman Pai championing the Office of Economics and Analytics at the commission. As many of the commentators have noted (Jamison, Hazlett, Wright, Ellig) the OEA was a step forward in nonpolitical, careful cost-benefit analysis at the commission. As Wright notes, Chairman Pai was careful to not just hire a bunch of economists, but rather to learn from other agencies that have better integrated economics, and to establish a structure that would enable the commission’s economists to materially contribute to better policy.

We were honored to receive a post from Jerry Ellig just a day before he tragically passed away. As chief economist at the FCC from 2017-2018, he was in a unique position to evaluate past practice and participate in the creation of the OEA. According to Ellig, past practice tended to treat the work of the commission’s economists as a post-hoc gloss on the work of the agency’s attorneys. Once conclusions were reached, economics would often be backfilled in to support those conclusions. With the establishment of the OEA, economics took a front-seat role, with staff of that office becoming a primary source for information and policy analysis before conclusions were reached. As Wright noted, the Federal Trade Commission had adopted this approach. With the FCC moving to do this as well, communications policy in the United States is on much sounder footing thanks to Chairman Pai.

Not only did Chairman Pai push the commission in the direction of nonpolitical, sound economic analysis but, as many commentators note, he significantly improved the process at the commission (Cooper, Jamison, Lyons). Chief among his contributions was making it a practice to publish proposed orders weeks in advance, breaking with past traditions of secrecy around draft orders, and thereby giving the public an opportunity to see what the commission intended to do.

Critics of Chairman Pai’s approach to transparency feared that allowing more public view into the process would chill negotiations between the commissioners behind the scenes. But as Daniel Lyons notes, the chairman’s approach was a smashing success:

The Pai era proved to be the most productive in recent memory, averaging just over six items per month, which is double the average number under Pai’s immediate predecessors. Moreover, deliberations were more bipartisan than in years past: Nathan Leamer notes that 61.4% of the items adopted by the Pai FCC were unanimous and 92.1% were bipartisan compared to 33% and 69.9%, respectively, under Chairman Wheeler.

Other reforms from Chairman Pai helped open the FCC to greater scrutiny and a more transparent process, including limiting editorial privileges on staff on an order’s text, and by introducing the use of a simple “fact sheet” to explain orders (Lyons).

I found one of the most interesting insights into the character of Chairman Pai, was his willingness to reverse course and take risks to ensure that the FCC promoted innovation instead of obstructing it by relying on received wisdom (Nachbar). For instance, although he was initially skeptical of the prospects of Space X to introduce broadband through its low-Earth-orbit satellite systems, under Chairman Pai, the Starlink beta program was included in the RDOF auction. It is not clear whether this was a good bet, Thomas Nachbar notes, but it was a statement both of the chairman’s willingness to change his mind, as well as to not allow policy to remain in a comfortable zone that excludes potential innovation.

The next chair has an awfully big pair of shoes (or one oversized coffee mug) to fill. Chairman Pai established an important legacy of transparency and process improvement, as well as commitment to careful, economic analysis in the business of the agency. We will all be well-served if future commissions follow in his footsteps.

[TOTM: The following is part of a digital symposium by TOTM guests and authors on the legal and regulatory issues that arose during Ajit Pai’s tenure as chairman of the Federal Communications Commission. The entire series of posts is available here.

Jerry Ellig was a research professor at The George Washington University Regulatory Studies Center and served as chief economist at the Federal Communications Commission from 2017 to 2018. Tragically, he passed away Jan. 20, 2021. TOTM is honored to publish his contribution to this symposium.]

One significant aspect of Chairman Ajit Pai’s legacy is not a policy change, but an organizational one: establishment of the Federal Communications Commission’s (FCC’s) Office of Economics and Analytics (OEA) in 2018.

Prior to OEA, most of the FCC’s economists were assigned to the various policy bureaus, such as Wireless, Wireline Competition, Public Safety, Media, and International. Each of these bureaus had its own chief economist, but the rank-and-file economists reported to the managers who ran the bureaus – usually attorneys who also developed policy and wrote regulations. In the words of former FCC Chief Economist Thomas Hazlett, the FCC had “no location anywhere in the organizational structure devoted primarily to economic analysis.”

Establishment of OEA involved four significant changes. First, most of the FCC’s economists (along with data strategists and auction specialists) are now grouped together into an organization separate from the policy bureaus, and they are managed by other economists. Second, the FCC rules establishing the new office tasked OEA with reviewing every rulemaking, reviewing every other item with economic content that comes before the commission for a vote, and preparing a full benefit-cost analysis for any regulation with $100 million or more in annual economic impact. Third, a joint memo from the FCC’s Office of General Counsel and OEA specifies that economists are to be involved in the early stages of all rulemakings. Fourth, the memo also indicates that FCC regulatory analysis should follow the principles articulated in Executive Order 12866 and Office of Management and Budget Circular A-4 (while specifying that the FCC, as an independent agency, is not bound by the executive order).

While this structure for managing economists was new for the FCC, it is hardly uncommon in federal regulatory agencies. Numerous independent agencies that deal with economic regulation house their economists in a separate bureau or office, including the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Surface Transportation Board, the Office of Comptroller of the Currency, and the Federal Trade Commission. The SEC displays even more parallels with the FCC. A guidance memo adopted in 2012 by the SEC’s Office of General Counsel and Division of Risk, Strategy and Financial Innovation (the name of the division where economists and other analysts were located) specifies that economists are to be involved in the early stages of all rulemakings and articulates best analytical practices based on Executive Order 12866 and Circular A-4.

A separate economics office offers several advantages over the FCC’s prior approach. It gives the economists greater freedom to offer frank advice, enables them to conduct higher-quality analysis more consistent with the norms of their profession, and may ultimately make it easier to uphold FCC rules that are challenged in court.

Independence.  When I served as chief economist at the FCC in 2017-2018, I gathered from conversations that the most common practice in the past was for attorneys who wrote rules to turn to economists for supporting analysis after key decisions had already been made. This was not always the process, but it often occurred. The internal working group of senior FCC career staff who drafted the plan for OEA reached similar conclusions. After the establishment of OEA, an FCC economist I interviewed noted how his role had changed: “My job used to be to support the policy decisions made in the chairman’s office. Now I’m much freer to speak my own mind.”

Ensuring economists’ independence is not a problem unique to the FCC. In a 2017 study, Stuart Shapiro found that most of the high-level economists he interviewed who worked on regulatory impact analyses in federal agencies perceive that economists can be more objective if they are located outside the program office that develops the regulations they are analyzing. As one put it, “It’s very difficult to conduct a BCA [benefit-cost analysis] if our boss wrote what you are analyzing.” Interviews with senior economists and non-economists who work on regulation that I conducted for an Administrative Conference of the United States project in 2019 revealed similar conclusions across federal agencies. Economists located in organizations separate from the program office said that structure gave them greater independence and ability to develop better analytical methodologies. On the other hand, economists located in program offices said they experienced or knew of instances where they were pressured or told to produce an analysis with the results decision-makers wanted.

The FTC provides an informative case study. From 1955-1961, many of the FTC’s economists reported to the attorneys who conducted antitrust cases; in 1961, they were moved into a separate Bureau of Economics. Fritz Mueller, the FTC chief economist responsible for moving the antitrust economists back into the Bureau of Economics, noted that they were originally placed under the antitrust attorneys because the attorneys wanted more control over the economic analysis. A 2015 evaluation by the FTC’s Inspector General concluded that the Bureau of Economics’ existence as a separate organization improves its ability to offer “unbiased and sound economic analysis to support decision-making.”

Higher-quality analysis. An issue closely related to economists’ independence is the quality of the economic analysis. Executive branch regulatory economists interviewed by Richard Williams expressed concern that the economic analysis was more likely to be changed to support decisions when the economists are located in the program office that writes the regulations. More generally, a study that Catherine Konieczny and I conducted while we were at the FCC found that executive branch agencies are more likely to produce higher-quality regulatory impact analyses if the economists responsible for the analysis are in an independent economics office rather than the program office.

Upholding regulations in court. In Michigan v. EPA, the Supreme Court held that it is unreasonable for agencies to refuse to consider regulatory costs if the authorizing statute does not prohibit them from doing so. This precedent will likely increase judicial expectations that agencies will consider economic issues when they issue regulations. The FCC’s OGC-OEA memo cites examples of cases where the quality of the FCC’s economic analysis either helped or harmed the commission’s ability to survive legal challenge under the Administrative Procedure Act’s “arbitrary and capricious” standard. More systematically, a recent Regulatory Studies Center working paper finds that a higher-quality economic analysis accompanying a regulation reduces the likelihood that courts will strike down the regulation, provided that the agency explains how it used the analysis in decisions.

Two potential disadvantages of a separate economics office are that it may make the economists easier to ignore (what former FCC Chief Economist Tim Brennan calls the “Siberia effect”) and may lead the economists to produce research that is less relevant to the practical policy concerns of the policymaking bureaus. The FCC’s reorganization plan took these disadvantages seriously.

To ensure that the ultimate decision-makers—the commissioners—have access to the economists’ analysis and recommendations, the rules establishing the office give OEA explicit responsibility for reviewing all items with economic content that come before the commission. Each item is accompanied by a cover memo that indicates whether OEA believes there are any significant issues, and whether they have been dealt with adequately. To ensure that economists and policy bureaus work together from the outset of regulatory initiatives, the OGC-OEA memo instructs:

Bureaus and Offices should, to the extent practicable, coordinate with OEA in the early stages of all Commission-level and major Bureau-level proceedings that are likely to draw scrutiny due to their economic impact. Such coordination will help promote productive communication and avoid delays from the need to incorporate additional analysis or other content late in the drafting process. In the earliest stages of the rulemaking process, economists and related staff will work with programmatic staff to help frame key questions, which may include drafting options memos with the lead Bureau or Office.

While presiding over his final commission meeting on Jan. 13, Pai commented, “It’s second nature now for all of us to ask, ‘What do the economists think?’” The real test of this institutional innovation will be whether that practice continues under a new chair in the next administration.

[TOTM: The following is part of a digital symposium by TOTM guests and authors on the legal and regulatory issues that arose during Ajit Pai’s tenure as chairman of the Federal Communications Commission. The entire series of posts is available here.

Joshua D. Wright is university professor and executive director of the Global Antitrust Institute at George Mason University’s Scalia Law School. He served as a commissioner of the Federal Trade Commission from 2013 through 2015.]

Much of this symposium celebrates Ajit’s contributions as chairman of the Federal Communications Commission and his accomplishments and leadership in that role. And rightly so. But Commissioner Pai, not just Chairman Pai, should also be recognized.

I first met Ajit when we were both minority commissioners at our respective agencies: the FCC and Federal Trade Commission. Ajit had started several months before I was confirmed. I watched his performance in the minority with great admiration. He reached new heights when he shifted from minority commissioner to chairman, and the accolades he will receive for that work are quite appropriate. But I want to touch on his time as a minority commissioner at the FCC and how that should inform the retrospective of his tenure.

Let me not bury the lead: Ajit Pai has been, in my view, the most successful, impactful minority commissioner in the history of the modern regulatory state. And it is that success that has led him to become the most successful and impactful chairman, too.

I must admit all of this success makes me insanely jealous. My tenure as a minority commissioner ran in parallel with Ajit. We joked together about our fierce duel to be the reigning king of regulatory dissents. We worked together fighting against net neutrality. We compared notes on dissenting statements and opinions. I tried to win our friendly competition. I tried pretty hard. And I lost; worse than I care to admit. But we had fun. And I very much admired the combination of analytical rigor, clarity of exposition, and intellectual honesty in his work. Anyway, the jealousy would be all too much if he weren’t also a remarkable person and friend.

The life of a minority commissioner can be a frustrating one. Like Sisyphus, the minority commissioner often wakes up each day to roll the regulatory (well, in this case, deregulatory) boulder up the hill, only to watch it roll down. And then do it again. And again. At times, it is an exhausting series of jousting matches with the windmills of Washington bureaucracy. It is not often that a minority commissioner has as much success as Commissioner Pai did: dissenting opinions ultimately vindicated by judicial review; substantive victories on critical policy issues; paving the way for institutional and procedural reforms.

It is one thing to write a raging dissent about how the majority has lost all principles. Fire and brimstone come cheap when there aren’t too many consequences to what you have to say. Measure a man after he has been granted power and a chance to use it, and only then will you have a true test of character. Ajit passes that test like few in government ever have.

This is part of what makes Ajit Pai so impressive. I have seen his work firsthand. The multitude of successes Ajit achieved as Chairman Pai were predictable, precisely because Commissioner Pai told the world exactly where he stood on important telecommunications policy issues, the reasons why he stood there, and then, well, he did what he said he would. The Pai regime was much more like a Le’Veon Bell run, between the tackles, than a no-look pass from Patrick Mahomes to Tyreek Hill. Commissioner Pai shared his playbook with the world; he told us exactly where he was going to run the ball. And then Chairman Pai did exactly that. And neither bureaucratic red tape nor political pressure—or even physical threat—could stop him.

Here is a small sampling of his contributions, many of them building on groundwork he laid in the minority:

Focus on Economic Analysis

One of Chairman Pai’s most important contributions to the FCC is his work to systematically incorporate economic analysis into FCC decision-making. The triumph of this effort was establishing the Office of Economic Analysis (OEA) in 2018. The OEA focus on conducting economic analyses of the costs, benefits, and economic impacts of the commission’s proposed rules will be a critical part of agency decision-making from here on out. This act alone would form a legacy any agency head could easily rest their laurels on. The OEA’s work will shape the agency for decades and ensure that agency decisions are made with the oversight economics provides.

This is a hard thing to do; just hiring economists is not enough. Structure matters. How economists get information to decision-makers determines if it will be taken seriously. To this end, Ajit has taken all the lessons from what has made the economists at the FTC so successful—and the lessons from the structural failures at other agencies—and applied them at the FCC.

Structural independence looks like “involving economists on cross-functional teams at the outset and allowing the economics division to make its own, independent recommendations to decision-makers.”[1] And it is necessary for economics to be taken seriously within an agency structure. Ajit has assured that FCC decision-making will benefit from economic analysis for years to come.

Narrowing the Digital Divide

Chairman Pai made helping the disadvantaged get connected to the internet and narrowing the digital divide the top priorities during his tenure. And Commissioner Pai was fighting for this long before the pandemic started.

As businesses, schools, work, and even health care have moved online, the need to get Americans connected with high-speed broadband has never been greater. Under Pai’s leadership, the FCC has removed bureaucratic barriers[2] and provided billions in funding[3] to facilitate rural broadband buildout. We are talking about connections to some 700,000 rural homes and businesses in 45 states, many of whom are gaining access to high-speed internet for the first time.

Ajit has also made sure to keep an eye out for the little guy, and communities that have been historically left behind. Tribal communities,[4] particularly in the rural West, have been a keen focus of his, as he knows all-too-well the difficulties and increased costs associated with servicing those lands. He established programs to rebuild and expand networks in the Virgin Islands and Puerto Rico[5] in an effort to bring the islands to parity with citizens living on the mainland.

You need not take my word for it; he really does talk about this all the time. As he said in a speech at the National Tribal Broadband Summit: “Since my first day in this job, I’ve said that closing the digital divide was my top priority. And as this audience knows all too well, nowhere is that divide more pronounced than on Tribal lands.“ That work is not done; it is beyond any one person. But Ajit should be recognized for his work bridging the divide and laying the foundation for future gains.

And again, this work started as minority commissioner. Before he was chairman, Pai proposed projects for rural broadband development; he frequently toured underserved states and communities; and he proposed legislation to offer the 21st century promise to economically depressed areas of the country. Looking at Chairman Pai is only half the picture.

Keeping Americans Connected

One would not think that the head of the Federal Communications Commission would be a leader on important health-care issues, but Ajit has made a real difference here too. One of his major initiatives has been the development of telemedicine solutions to expand access to care in critical communities.

Beyond encouraging buildout of networks in less-connected areas, Pai’s FCC has also worked to allocate funding for health-care providers and educational institutions who were navigating the transition to remote services. He ensured that health-care providers’ telecommunications and information services were funded. He worked with the U.S. Department of Education to direct funds for education stabilization and allowed schools to purchase additional bandwidth. And he granted temporary additional spectrum usage to broadband providers to meet the increased demand upon our nation’s networks. Oh, and his Keep Americans Connected Pledge gathered commitment from more than 800 companies to ensure that Americans would not lose their connectivity due to pandemic-related circumstances. As if the list were not long enough, Congress’ January coronavirus relief package will ensure that these and other programs, like Rip and Replace, will remain funded for the foreseeable future.

I might sound like I am beating a dead horse here, but the seeds of this, too, were laid in his work in the minority. Here he is describing his work in a 2015 interview, as a minority commissioner:

My own father is a physician in rural Kansas, and I remember him heading out in his car to visit the small towns that lay 40 miles or more from home. When he was there, he could provide care for people who would otherwise never see a specialist at all. I sometimes wonder, back in the 1970s and 1980s, how much easier it would have been on patients, and him, if broadband had been available so he could provide healthcare online.

Agency Transparency and Democratization

Many minority commissioners like to harp on agency transparency. Some take a different view when they are in charge. But Ajit made good on his complaints about agency transparency when he became Chairman Pai. He did this through circulating draft items well in advance of monthly open meetings, giving people the opportunity to know what the agency was voting on.

You used to need a direct connection with the FCC to even be aware of what orders were being discussed—the worst of the D.C. swamp—but now anyone can read about the working items, in clear language.

These moves toward a more transparent, accessible FCC dispel the impression that the agency is run by Washington insiders who are disconnected from the average person. The meetings may well be dry and technical—they really are—but Chairman Pai’s statements are not only good-natured and humorous, but informative and substantive. The public has been well-served by his efforts here.

Incentivizing Innovation and Next-Generation Technologies

Chairman Pai will be remembered for his encouragement of innovation. Under his chairmanship, the FCC discontinued rules that unnecessarily required carriers to maintain costly older, lower-speed networks and legacy voice services. It streamlined the discontinuance process for lower-speed services if the carrier is already providing higher-speed service or if no customers are using the service. It also okayed streamlined notice following force majeure events like hurricanes to encourage investment and deployment of newer, faster infrastructure and services following destruction of networks. The FCC also approved requests by companies to provide high-speed broadband through non-geostationary orbit satellite constellations and created a streamlined licensing process for small satellites to encourage faster deployment.

This is what happens when you get a tech nerd at the head of an agency he loves and cares for. A serious commitment to good policy with an eye toward the future.

Restoring Internet Freedom

This is a pretty sensitive one for me. You hear less about it now, other than some murmurs from the Biden administration about changing it, but the debate over net neutrality got nasty and apocalyptic.

It was everywhere; people saying Chairman Pai would end the internet as we know it. The whole web blacked out for a day in protest. People mocked up memes showing a 25 cent-per-Google-search charge. And as a result of this over-the-top rhetoric, my friend, and his family, received death threats.

That is truly beyond the pale. One could not blame anyone for leaving public service in such an environment. I cannot begin to imagine what I would have done in Ajit’s place. But Ajit took the threats on his life with grace and dignity, never lost his sense of humor, and continued to serve the public dutifully with remarkable courage. I think that says a lot about him. And the American public is lucky to have benefited from his leadership.

Now, for the policy stuff. Though it should go without saying, the light-touch framework Chairman Pai returned us to—as opposed to the public utility one—will ensure that the United States maintains its leading position on technological innovation in 5G networks and services. The fact that we have endured COVID—and the massive strain on the internet it has caused—with little to no noticeable impact on internet services is all the evidence you need he made the right choice. Ajit has rightfully earned the title of the “5G Chairman.”

Conclusion

I cannot give Ajit all the praise he truly deserves without sounding sycophantic, or bribed. There are any number of windows into his character, but one rises above the rest for me. And I wanted to take the extra time to thank Ajit for it.

Every year, without question, no matter what was going on—even as chairman—Ajit would come to my classes and talk to my students. At length. In detail. And about any subject they wished. He stayed until he answered all of their questions. If I didn’t politely shove him out of the class to let him go do his real job, I’m sure he would have stayed until the last student left. And if you know anything about how to judge a person’s character, that will tell you all you need to know. 

Congratulations, Chairman Pai.


[1] Jerry Ellig & Catherine Konieczny, The Organization of Economists in Regulatory Agencies: Does Structure Matter?

[2] Rural Digital Opportunity Fund, Fed. Commc’ns Comm’n, https://www.fcc.gov/auction/904.

[3] Press Release, Connect America Fund Auction to Expand Broadband to Over 700,000 Rural Homes and Businesses: Auction Allocates $1.488 Billion to Close the Digital Divide, Fed. Commc’ns Comm’n, https://docs.fcc.gov/public/attachments/DOC-353840A1.pdf.

[4] Press Release, FCC Provides Relief for Carriers Serving Tribal Lands, Fed. Commc’ns Comm’n, https://www.fcc.gov/document/fcc-provides-relief-carriers-serving-tribal-lands.

[5] Press Release, FCC Approves $950 Million to Harden, Improve, and Expand Broadband Networks in Puerto Rico and U.S. Virgin Islands, Fed. Commc’ns Comm’n, https://docs.fcc.gov/public/attachments/DOC-359891A1.pdf.

[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]

The U.S. Department of Justice’s (DOJ) antitrust case against Google, which was filed in October 2020, will be a tough slog.[1] It is an alleged monopolization (Sherman Act, Sec. 2) case; and monopolization cases are always a tough slog.

In this brief essay I will lay out some of the issues in the case and raise an intriguing possibility.

What is the case about?

The case is about exclusivity and exclusion in the distribution of search engine services; that Google paid substantial sums to Apple and to the manufacturers of Android-based mobile phones and tablets and also to wireless carriers and web-browser proprietors—in essence, to distributors—to install the Google search engine as the exclusive pre-set (installed), default search program. The suit alleges that Google thereby made it more difficult for other search-engine providers (e.g., Bing; DuckDuckGo) to obtain distribution for their search-engine services and thus to attract search-engine users and to sell the online advertising that is associated with search-engine use and that provides the revenue to support the search “platform” in this “two-sided market” context.[2]

Exclusion can be seen as a form of “raising rivals’ costs.”[3]  Equivalently, exclusion can be seen as a form of non-price predation. Under either interpretation, the exclusionary action impedes competition.

It’s important to note that these allegations are different from those that motivated an investigation by the Federal Trade Commission (which the FTC dropped in 2013) and the cases by the European Union against Google.[4]  Those cases focused on alleged self-preferencing; that Google was unduly favoring its own products and services (e.g., travel services) in its delivery of search results to users of its search engine. In those cases, the impairment of competition (arguably) happens with respect to those competing products and services, not with respect to search itself.

What is the relevant market?

For a monopolization allegation to have any meaning, there needs to be the exercise of market power (which would have adverse consequences for the buyers of the product). And in turn, that exercise of market power needs to occur in a relevant market: one in which market power can be exercised.

Here is one of the important places where the DOJ’s case is likely to turn into a slog: the delineation of a relevant market for alleged monopolization cases remains as a largely unsolved problem for antitrust economics.[5]  This is in sharp contrast to the issue of delineating relevant markets for the antitrust analysis of proposed mergers.  For this latter category, the paradigm of the “hypothetical monopolist” and the possibility that this hypothetical monopolist could prospectively impose a “small but significant non-transitory increase in price” (SSNIP) has carried the day for the purposes of market delineation.

But no such paradigm exists for monopolization cases, in which the usual allegation is that the defendant already possesses market power and has used the exclusionary actions to buttress that market power. To see the difficulties, it is useful to recall the basic monopoly diagram from Microeconomics 101. A monopolist faces a negatively sloped demand curve for its product (at higher prices, less is bought; at lower prices, more is bought) and sets a profit-maximizing price at the level of output where its marginal revenue (MR) equals its marginal costs (MC). Its price is thereby higher than an otherwise similar competitive industry’s price for that product (to the detriment of buyers) and the monopolist earns higher profits than would the competitive industry.

But unless there are reliable benchmarks as to what the competitive price and profits would otherwise be, any information as to the defendant’s price and profits has little value with respect to whether the defendant already has market power. Also, a claim that a firm does not have market power because it faces rivals and thus isn’t able profitably to raise its price from its current level (because it would lose too many sales to those rivals) similarly has no value. Recall the monopolist from Micro 101. It doesn’t set a higher price than the one where MR=MC, because it would thereby lose too many sales to other sellers of other things.

Thus, any firm—regardless of whether it truly has market power (like the Micro 101 monopolist) or is just another competitor in a sea of competitors—should have already set its price at its profit-maximizing level and should find it unprofitable to raise its price from that level.[6]  And thus the claim, “Look at all of the firms that I compete with!  I don’t have market power!” similarly has no informational value.

Let us now bring this problem back to the Google monopolization allegation:  What is the relevant market?  In the first instance, it has to be “the provision of answers to user search queries.” After all, this is the “space” in which the exclusion occurred. But there are categories of search: e.g., search for products/services, versus more general information searches (“What is the current time in Delaware?” “Who was the 21st President of the United States?”). Do those separate categories themselves constitute relevant markets?

Further, what would the exercise of market power in a (delineated relevant) market look like?  Higher-than-competitive prices for advertising that targets search-results recipients is one obvious answer (but see below). In addition, because this is a two-sided market, the competitive “price” (or prices) might involve payments by the search engine to the search users (in return for their exposure to the lucrative attached advertising).[7]  And product quality might exhibit less variety than a competitive market would provide; and/or the monopolistic average level of quality would be lower than in a competitive market: e.g., more abuse of user data, and/or deterioration of the delivered information itself, via more self-preferencing by the search engine and more advertising-driven preferencing of results.[8]

In addition, a natural focus for a relevant market is the advertising that accompanies the search results. But now we are at the heart of the difficulty of delineating a relevant market in a monopolization context. If the relevant market is “advertising on search engine results pages,” it seems highly likely that Google has market power. If the relevant market instead is all online U.S. advertising (of which Google’s revenue share accounted for 32% in 2019[9]), then the case is weaker; and if the relevant market is all advertising in the United States (which is about twice the size of online advertising[10]), the case is weaker still. Unless there is some competitive benchmark, there is no easy way to delineate the relevant market.[11]

What exactly has Google been paying for, and why?

As many critics of the DOJ’s case have pointed out, it is extremely easy for users to switch their default search engine. If internet search were a normal good or service, this ease of switching would leave little room for the exercise of market power. But in that case, why is Google willing to pay $8-$12 billion annually for the exclusive default setting on Apple devices and large sums to the manufacturers of Android-based devices (and to wireless carriers and browser proprietors)? Why doesn’t Google instead run ads in prominent places that remind users how superior Google’s search results are and how easy it is for users (if they haven’t already done so) to switch to the Google search engine and make Google the user’s default choice?

Suppose that user inertia is important. Further suppose that users generally have difficulty in making comparisons with respect to the quality of delivered search results. If this is true, then being the default search engine on Apple and Android-based devices and on other distribution vehicles would be valuable. In this context, the inertia of their customers is a valuable “asset” of the distributors that the distributors may not be able to take advantage of, but that Google can (by providing search services and selling advertising). The question of whether Google’s taking advantage of this user inertia means that Google exercises market power takes us back to the issue of delineating the relevant market.

There is a further wrinkle to all of this. It is a well-understood concept in antitrust economics that an incumbent monopolist will be willing to pay more for the exclusive use of an essential input than a challenger would pay for access to the input.[12] The basic idea is straightforward. By maintaining exclusive use of the input, the incumbent monopolist preserves its (large) monopoly profits. If the challenger enters, the incumbent will then earn only its share of the (much lower, more competitive) duopoly profits. Similarly, the challenger can expect only the lower duopoly profits. Accordingly, the incumbent should be willing to outbid (and thereby exclude) the challenger and preserve the incumbent’s exclusive use of the input, so as to protect those monopoly profits.

To bring this to the Google monopolization context, if Google does possess market power in some aspect of search—say, because online search-linked advertising is a relevant market—then Google will be willing to outbid Microsoft (which owns Bing) for the “asset” of default access to Apple’s (inertial) device owners. That Microsoft is a large and profitable company and could afford to match (or exceed) Google’s payments to Apple is irrelevant. If the duopoly profits for online search-linked advertising would be substantially lower than Google’s current profits, then Microsoft would not find it worthwhile to try to outbid Google for that default access asset.

Alternatively, this scenario could be wholly consistent with an absence of market power. If search users (who can easily switch) consider Bing to be a lower-quality search service, then large payments by Microsoft to outbid Google for those exclusive default rights would be largely wasted, since the “acquired” default search users would quickly switch to Google (unless Microsoft provided additional incentives for the users not to switch).

But this alternative scenario returns us to the original puzzle:  Why is Google making such large payments to the distributors for those exclusive default rights?

An intriguing possibility

Consider the following possibility. Suppose that Google was paying that $8-$12 billion annually to Apple in return for the understanding that Apple would not develop its own search engine for Apple’s device users.[13] This possibility was not raised in the DOJ’s complaint, nor is it raised in the subsequent suits by the state attorneys general.

But let’s explore the implications by going to an extreme. Suppose that Google and Apple had a formal agreement that—in return for the $8-$12 billion per year—Apple would not develop its own search engine. In this event, this agreement not to compete would likely be seen as a violation of Section 1 of the Sherman Act (which does not require a market delineation exercise) and Apple would join Google as a co-conspirator. The case would take on the flavor of the FTC’s prosecution of “pay-for-delay” agreements between the manufacturers of patented pharmaceuticals and the generic drug manufacturers that challenge those patents and then receive payments from the former in return for dropping the patent challenge and delaying the entry of the generic substitute.[14]

As of this writing, there is no evidence of such an agreement and it seems quite unlikely that there would have been a formal agreement. But the DOJ will be able to engage in discovery and take depositions. It will be interesting to find out what the relevant executives at Google—and at Apple—thought was being achieved by those payments.

What would be a suitable remedy/relief?

The DOJ’s complaint is vague with respect to the remedy that it seeks. This is unsurprising. The DOJ may well want to wait to see how the case develops and then amend its complaint.

However, even if Google’s actions have constituted monopolization, it is difficult to conceive of a suitable and effective remedy. One apparently straightforward remedy would be to require simply that Google not be able to purchase exclusivity with respect to the pre-set default settings. In essence, the device manufacturers and others would always be able to sell parallel default rights to other search engines: on the basis, say, that the default rights for some categories of customers—or even a percentage of general customers (randomly selected)—could be sold to other search-engine providers.

But now the Gilbert-Newbery insight comes back into play. Suppose that a device manufacturer knows (or believes) that Google will pay much more if—even in the absence of any exclusivity agreement—Google ends up being the pre-set search engine for all (or nearly all) of the manufacturer’s device sales, as compared with what the manufacturer would receive if those default rights were sold to multiple search-engine providers (including, but not solely, Google). Can that manufacturer (recall that the distributors are not defendants in the case) be prevented from making this sale to Google and thus (de facto) continuing Google’s exclusivity?[15]

Even a requirement that Google not be allowed to make any payment to the distributors for a default position may not improve the competitive environment. Google may be able to find other ways of making indirect payments to distributors in return for attaining default rights, e.g., by offering them lower rates on their online advertising.

Further, if the ultimate goal is an efficient outcome in search, it is unclear how far restrictions on Google’s bidding behavior should go. If Google were forbidden from purchasing any default installation rights for its search engine, would (inert) consumers be better off? Similarly, if a distributor were to decide independently that its customers were better served by installing the Google search engine as the default, would that not be allowed? But if it is allowed, how could one be sure that Google wasn’t indirectly paying for this “independent” decision (e.g., through favorable advertising rates)?

It’s important to remember that this (alleged) monopolization is different from the Standard Oil case of 1911 or even the (landline) AT&T case of 1984. In those cases, there were physical assets that could be separated and spun off to separate companies. For Google, physical assets aren’t important. Although it is conceivable that some of Google’s intellectual property—such as Gmail, YouTube, or Android—could be spun off to separate companies, doing so would do little to cure the (arguably) fundamental problem of the inert device users.

In addition, if there were an agreement between Google and Apple for the latter not to develop a search engine, then large fines for both parties would surely be warranted. But what next? Apple can’t be forced to develop a search engine.[16] This differentiates such an arrangement from the “pay-for-delay” arrangements for pharmaceuticals, where the generic manufacturers can readily produce a near-identical substitute for the patented drug and are otherwise eager to do so.

At the end of the day, forbidding Google from paying for exclusivity may well be worth trying as a remedy. But as the discussion above indicates, it is unlikely to be a panacea and is likely to require considerable monitoring for effective enforcement.

Conclusion

The DOJ’s case against Google will be a slog. There are unresolved issues—such as how to delineate a relevant market in a monopolization case—that will be central to the case. Even if the DOJ is successful in showing that Google violated Section 2 of the Sherman Act in monopolizing search and/or search-linked advertising, an effective remedy seems problematic. But there also remains the intriguing question of why Google was willing to pay such large sums for those exclusive default installation rights?

The developments in the case will surely be interesting.


[1] The DOJ’s suit was joined by 11 states.  More states subsequently filed two separate antitrust lawsuits against Google in December.

[2] There is also a related argument:  That Google thereby gained greater volume, which allowed it to learn more about its search users and their behavior, and which thereby allowed it to provide better answers to users (and thus a higher-quality offering to its users) and better-targeted (higher-value) advertising to its advertisers.  Conversely, Google’s search-engine rivals were deprived of that volume, with the mirror-image negative consequences for the rivals.  This is just another version of the standard “learning-by-doing” and the related “learning curve” (or “experience curve”) concepts that have been well understood in economics for decades.

[3] See, for example, Steven C. Salop and David T. Scheffman, “Raising Rivals’ Costs: Recent Advances in the Theory of Industrial Structure,” American Economic Review, Vol. 73, No. 2 (May 1983), pp.  267-271; and Thomas G. Krattenmaker and Steven C. Salop, “Anticompetitive Exclusion: Raising Rivals’ Costs To Achieve Power Over Price,” Yale Law Journal, Vol. 96, No. 2 (December 1986), pp. 209-293.

[4] For a discussion, see Richard J. Gilbert, “The U.S. Federal Trade Commission Investigation of Google Search,” in John E. Kwoka, Jr., and Lawrence J. White, eds. The Antitrust Revolution: Economics, Competition, and Policy, 7th edn.  Oxford University Press, 2019, pp. 489-513.

[5] For a more complete version of the argument that follows, see Lawrence J. White, “Market Power and Market Definition in Monopolization Cases: A Paradigm Is Missing,” in Wayne D. Collins, ed., Issues in Competition Law and Policy. American Bar Association, 2008, pp. 913-924.

[6] The forgetting of this important point is often termed “the cellophane fallacy”, since this is what the U.S. Supreme Court did in a 1956 antitrust case in which the DOJ alleged that du Pont had monopolized the cellophane market (and du Pont, in its defense claimed that the relevant market was much wider: all flexible wrapping materials); see U.S. v. du Pont, 351 U.S. 377 (1956).  For an argument that profit data and other indicia argued for cellophane as the relevant market, see George W. Stocking and Willard F. Mueller, “The Cellophane Case and the New Competition,” American Economic Review, Vol. 45, No. 1 (March 1955), pp. 29-63.

[7] In the context of differentiated services, one would expect prices (positive or negative) to vary according to the quality of the service that is offered.  It is worth noting that Bing offers “rewards” to frequent searchers; see https://www.microsoft.com/en-us/bing/defaults-rewards.  It is unclear whether this pricing structure of payment to Bing’s customers represents what a more competitive framework in search might yield, or whether the payment just indicates that search users consider Bing to be a lower-quality service.

[8] As an additional consequence of the impairment of competition in this type of search market, there might be less technological improvement in the search process itself – to the detriment of users.

[9] As estimated by eMarketer: https://www.emarketer.com/newsroom/index.php/google-ad-revenues-to-drop-for-the-first-time/.

[10] See https://www.visualcapitalist.com/us-advertisers-spend-20-years/.

[11] And, again, if we return to the du Pont cellophane case:  Was the relevant market cellophane?  Or all flexible wrapping materials?

[12] This insight is formalized in Richard J. Gilbert and David M.G. Newbery, “Preemptive Patenting and the Persistence of Monopoly,” American Economic Review, Vol. 72, No. 3 (June 1982), pp. 514-526.

[13] To my knowledge, Randal C. Picker was the first to suggest this possibility; see https://www.competitionpolicyinternational.com/a-first-look-at-u-s-v-google/.  Whether Apple would be interested in trying to develop its own search engine – given the fiasco a decade ago when Apple tried to develop its own maps app to replace the Google maps app – is an open question.  In addition, the Gilbert-Newbery insight applies here as well:  Apple would be less inclined to invest the substantial resources that would be needed to develop a search engine when it is thereby in a duopoly market.  But Google might be willing to pay “insurance” to reinforce any doubts that Apple might have.

[14] The U.S. Supreme Court, in FTC v. Actavis, 570 U.S. 136 (2013), decided that such agreements could be anti-competitive and should be judged under the “rule of reason”.  For a discussion of the case and its implications, see, for example, Joseph Farrell and Mark Chicu, “Pharmaceutical Patents and Pay-for-Delay: Actavis (2013),” in John E. Kwoka, Jr., and Lawrence J. White, eds. The Antitrust Revolution: Economics, Competition, and Policy, 7th edn.  Oxford University Press, 2019, pp. 331-353.

[15] This is an example of the insight that vertical arrangements – in this case combined with the Gilbert-Newbery effect – can be a way for dominant firms to raise rivals’ costs.  See, for example, John Asker and Heski Bar-Isaac. 2014. “Raising Retailers’ Profits: On Vertical Practices and the Exclusion of Rivals.” American Economic Review, Vol. 104, No. 2 (February 2014), pp. 672-686.

[16] And, again, for the reasons discussed above, Apple might not be eager to make the effort.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Noah Phillips[1] (Commissioner of the U.S. Federal Trade Commission).]   

Never let a crisis go to waste, or so they say. In the past two weeks, some of the same people who sought to stop mergers and acquisitions during the bull market took the opportunity of the COVID-19 pandemic and the new bear market to call to ban M&A. On Friday, April 24th, Rep. David Cicilline proposed that a merger ban be included in the next COVID-19-related congressional legislative package.[2] By Monday, Senator Elizabeth Warren and Rep. Alexandria Ocasio-Cortez, warning of “predatory” M&A and private equity “vultures”, teamed up with a similar proposal.[3] 

I’m all for stopping anticompetitive M&A that we cannot resolve. In the past few months alone, the Federal Trade Commission has been quite busy, suing to stop transactions in the hospital, e-cigarette, coal, body-worn camera, razor, and gene sequencing industries, and forcing deals to stop in the pharmaceutical, medical staffing, and consumer products spaces. But is a blanket ban, unprecedented in our nation’s history, warranted, now? 

The theory that the pandemic requires the government to shut down M&A goes something like this: the antitrust agencies are overwhelmed and cannot do the job of reviewing mergers under the Hart-Scott-Rodino (HSR) Act, which gives the U.S. antitrust agencies advance notice of certain transactions and 30 days to decide whether to seek more information about them.[4] That state of affairs will, in turn, invite a rush of companies looking to merge with minimal oversight, exacerbating the problem by flooding the premerger notification office (PNO) with new filings. Another version holds, along similar lines, that the precipitous decline in the market will precipitate a merger “wave” in which “dominant corporations” and “private equity vultures” will gobble up defenseless small businesses. Net result: anticompetitive transactions go unnoticed and unchallenged. That’s the theory, at least as it has been explained to me. The facts are different.

First, while the restrictions related to COVID-19 require serious adjustments at the antitrust agencies just as they do at workplaces across the country (we’re working from home, dealing with remote technology, and handling kids just like the rest), merger review continues. Since we started teleworking, the FTC has, among other things, challenged Altria’s $12.8 billion investment in JUUL’s e-cigarette business and resolved competitive concerns with GE’s sale of its biopharmaceutical business to Danaher and Ossur’s acquisition of a competing prosthetic limbs manufacturer, College Park. With our colleagues at the Antitrust Division of the Department of Justice, we announced a new e-filing system for HSR filings and temporarily suspended granting early termination. We sought voluntary extensions from companies. But, in less than two weeks, we were able to resume early termination—back to “new normal”, at least. I anticipate there may be additional challenges; and the FTC will assess constraints in real-time to deal with further disruptions. But we have not sacrificed the thoroughness of our investigations; and we will not.

Second, there is no evidence of a merger “wave”, or that the PNO is overwhelmed with HSR filings. To the contrary, according to Bloomberg, monthly M&A volume hit rock bottom in April – the lowest since 2004. As of last week, the PNO estimates nearly 60% reduction in HSR reported transactions during the past month, compared to the historical average. Press reports indicate that M&A activity is down dramatically because of the crisis. Xerox recently announced it was suspending its hostile bid for Hewlett-Packard ($30 billion); private equity firm Sycamore Partners announced it is walking away from its takeover of Victoria’s Secret ($525 million); and Boeing announced it is backing out of its merger with Embraer ($4.2 billion) — just a few examples of companies, large corporations and private equity firms alike, stopping M&A on their own. (The market is funny like that.)

Slowed M&A during a global pandemic and economic crisis is exactly what you would expect. The financial uncertainty facing companies lowers shareholder and board confidence to dive into a new acquisition or sale. Financing is harder to secure. Due diligence is postponed. Management meetings are cancelled. Agreeing on price is another big challenge. The volatility in stock prices makes valuation difficult, and lessens the value of equity used to acquire. Cash is needed elsewhere, like to pay workers and keep operations running. Lack of access to factories and other assets as a result of travel restrictions and stay-at-home orders similarly make valuation harder. Management can’t even get in a room to negotiate and hammer out the deal because of social distancing (driving a hard bargain on Zoom may not be the same).

Experience bears out those expectations. Consider our last bear market, the financial crisis that took place over a decade ago. Publicly available FTC data show the number of HSR reported transactions dropped off a cliff. During fiscal year 2009, the height of the crisis, HSR reported transactions were down nearly 70% compared to just two years earlier, in fiscal year 2007. Not surprising.

Source: https://www.ftc.gov/site-information/open-government/data-sets

Nor should it be surprising that the current crisis, with all its uncertainty and novelty, appears itself to be slowing down M&A.

So, the antitrust agencies are continuing merger review, and adjusting quickly to the new normal. M&A activity is down, dramatically, on its own. That makes the pandemic an odd excuse to stop M&A. Maybe the concern wasn’t really about the pandemic in the first place? The difference in perspective may depend on one’s general view of the value of M&A. If you think mergers are mostly (or all) bad, and you discount the importance of the market for corporate control, the cost to stopping them all is low. If you don’t, the cost is high.[5]

As a general matter, decades of research and experience tell us that the vast majority of mergers are either pro-competitive or competitively-neutral.[6] But M&A, even dramatically-reduced, also has an important role to play in a moment of economic adjustment. It helps allocate assets in an efficient manner, for example giving those with the wherewithal to operate resources (think companies, or plants) an opportunity that others may be unable to utilize. Consumers benefit if a merger leads to the delivery of products or services that one company could not efficiently provide on its own, and from the innovation and lower prices that better management and integration can provide. Workers benefit, too, as they remain employed by going concerns.[7] It serves no good, including for competition, to let companies that might live, die.[8]

M&A is not the only way in which market forces can help. The antitrust agencies have always recognized pro-competitive benefits to collaboration between competitors during times of crisis.  In 2005, after hurricanes Katrina and Rita, we implemented an expedited five-day review of joint projects between competitors aimed at relief and construction. In 2017, after hurricanes Harvey and Irma, we advised that hospitals could combine resources to meet the health care needs of affected communities and companies could combine distribution networks to ensure goods and services were available. Most recently, in response to the current COVID-19 emergency, we announced an expedited review process for joint ventures. Collaboration can be concerning, so we’re reviewing; but it can also help.

Our nation is going through an unprecedented national crisis, with a horrible economic component that is putting tens of millions out of work and causing a great deal of suffering. Now is a time of great uncertainty, tragedy, and loss; but also of continued hope and solidarity. While merger review is not the top-of-mind issue for many—and it shouldn’t be—American consumers stand to gain from pro-competitive mergers, during and after the current crisis. Those benefits would be wiped out with a draconian ‘no mergers’ policy during the COVID-19 emergency. Might there be anticompetitive merger activity? Of course, which is why FTC staff are working hard to vet potentially anticompetitive mergers and prevent harm to consumers. Let’s let them keep doing their jobs.


[1] The views expressed in this blog post are my own and do not necessarily reflect the views of the Federal Trade Commission or any other commissioner. An abbreviated version of this essay was previously published in the New York Times’ DealBook newsletter. Noah Phillips, The case against banning mergers, N.Y. Times, Apr. 27, 2020, available at https://www.nytimes.com/2020/04/27/business/dealbook/small-business-ppp-loans.html.

[2] The proposal would allow transactions only if a company is already in bankruptcy or is otherwise about to fail.

[3] The “Pandemic Anti-Monopoly Act” proposes a merger moratorium on (1) firms with over $100 million in revenue or market capitalization of over $100 million; (2) PE firms and hedge funds (or entities that are majority-owned by them); (3) businesses that have an exclusive patent on products related to the crisis, such as personal protective equipment; and (4) all HSR reportable transactions.

[4] Hart-Scott-Rodino Antitrust Improvements Act of 1976, 15 U.S.C. § 18a. The antitrust agencies can challenge transactions after they happen, but they are easier to stop beforehand; and Congress designed HSR to give us an opportunity to do so.

[5] Whatever your view, the point is that the COVID-19 crisis doesn’t make sense as a justification for banning M&A. If ban proponents oppose M&A generally, they should come out and say that. And they should level with the public about just how much they propose to ban. The specifics of the proposals are beyond the scope of this essay, but it’s worth noting that the “large companies [gobbling] up . . . small businesses” of which Sen. Warren warns include any firm with $100 million in annual revenue and anyone making a transaction reportable under HSR. $100 million seems like a lot of money to many of us, but the Ohio State University National Center for the Middle Market defines a mid-sized company as having annual revenues between $10 million and $1 billion. Many if not most of the transactions that would be banned look nothing like the kind of acquisitions ban proponents are describing.

[6] As far back as the 1980s, the Horizontal Merger Guidelines reflected this idea, stating: “While challenging competitively harmful mergers, the Department [of Justice Antitrust Division] seeks to avoid unnecessary interference with the larger universe of mergers that are either competitively beneficial or neutral.” Horizontal Merger Guidelines (1982); see also Hovenkamp, Appraising Merger Efficiencies, 24 Geo. Mason L. Rev. 703, 704 (2017) (“we tolerate most mergers because of a background, highly generalized belief that most—or at least many—do produce cost savings or improvements in products, services, or distribution”); Andrade, Mitchell & Stafford, New Evidence and Perspectives on Mergers, 15 J. ECON. PERSPECTIVES 103, 117 (2001) (“We are inclined to defend the traditional view that mergers improve efficiency and that the gains to shareholders at merger announcement accurately reflect improved expectations of future cash flow performance.”).

[7] Jointly with our colleagues at the Antitrust Division of the Department of Justice, we issued a statement last week affirming our commitment to enforcing the antitrust laws against those who seek to exploit the pandemic to engage in anticompetitive conduct in labor markets.

[8] The legal test to make such a showing for an anti-competitive transaction is high. Known as the “failing firm defense”, it is available only to firms that can demonstrate their fundamental inability to compete effectively in the future. The Horizontal Merger Guidelines set forth three elements to establish the defense: (1) the allegedly failing firm would be unable to meet its financial obligations in the near future; (2) it would not be able to reorganize successfully under Chapter 11; and (3) it has made unsuccessful good-faith efforts to elicit reasonable alternative offers that would keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than the actual merger. Horizontal Merger Guidelines § 11; see also Citizen Publ’g v. United States, 394 U.S. 131, 137-38 (1969). The proponent of the failing firm defense bears the burden to prove each element, and failure to prove a single element is fatal. In re Otto Bock, FTC No. 171-0231, Docket No. 9378 Commission Opinion (Nov. 2019) at 43; see also Citizen Publ’g, 394 U.S. at 138-39.

Since the LabMD decision, in which the Eleventh Circuit Court of Appeals told the FTC that its orders were unconstitutionally vague, the FTC has been put on notice that it needs to reconsider how it develops and substantiates its claims in data security enforcement actions brought under Section 5. 

Thus, on January 6, the FTC announced on its blog that it will have “New and improved FTC data security orders: Better guidance for companies, better protection for consumers.” However, the changes the Commission highlights only get to a small part of what we have previously criticized when it comes to their “common law” of data security (see here and here). 

While the new orders do list more specific requirements to help explain what the FTC believes is a “comprehensive data security program”, there is still no legal analysis in either the orders or the complaints that would give companies fair notice of what the law requires. Furthermore, nothing about the underlying FTC process has changed, which means there is still enormous pressure for companies to settle rather than litigate the contours of what “reasonable” data security practices look like. Thus, despite the Commission’s optimism, the recent orders and complaints do little to nothing to remedy the problems that plague the Commission’s data security enforcement program.

The changes

In his blog post, the director of the Bureau of Consumer Protection at the FTC describes how new orders in data security enforcement actions are more specific, with one of the main goals being more guidance to businesses trying to follow the law.

Since the early 2000s, our data security orders had contained fairly standard language. For example, these orders typically required a company to implement a comprehensive information security program subject to a biennial outside assessment. As part of the FTC’s Hearings on Competition and Consumer Protection in the 21st Century, we held a hearing in December 2018 that specifically considered how we might improve our data security orders. We were also mindful of the 11th Circuit’s 2018 LabMD decision, which struck down an FTC data security order as unenforceably vague.

Based on this learning, in 2019 the FTC made significant improvements to its data security orders. These improvements are reflected in seven orders announced this year against an array of diverse companies: ClixSense (pay-to-click survey company), i-Dressup (online games for kids), DealerBuilt (car dealer software provider), D-Link (Internet-connected routers and cameras), Equifax (credit bureau), Retina-X (monitoring app), and Infotrax (service provider for multilevel marketers)…

[T]he orders are more specific. They continue to require that the company implement a comprehensive, process-based data security program, and they require the company to implement specific safeguards to address the problems alleged in the complaint. Examples have included yearly employee training, access controls, monitoring systems for data security incidents, patch management systems, and encryption. These requirements not only make the FTC’s expectations clearer to companies, but also improve order enforceability.

Why the FTC’s data security enforcement regime fails to provide fair notice or develop law (and is not like the common law)

While these changes are long overdue, it is just one step in the direction of a much-needed process reform at the FTC in how it prosecutes cases with its unfairness authority, particularly in the realm of data security. It’s helpful to understand exactly why the historical failures of the FTC process are problematic in order to understand why the changes it is undertaking are insufficient.

For instance, Geoffrey Manne and I previously highlighted  the various ways the FTC’s data security consent order regime fails in comparison with the common law: 

In Lord Mansfield’s characterization, “the common law ‘does not consist of particular cases, but of general principles, which are illustrated and explained by those cases.’” Further, the common law is evolutionary in nature, with the outcome of each particular case depending substantially on the precedent laid down in previous cases. The common law thus emerges through the accretion of marginal glosses on general rules, dictated by new circumstances. 

The common law arguably leads to legal rules with at least two substantial benefits—efficiency and predictability or certainty. The repeated adjudication of inefficient or otherwise suboptimal rules results in a system that generally offers marginal improvements to the law. The incentives of parties bringing cases generally means “hard cases,” and thus judicial decisions that have to define both what facts and circumstances violate the law and what facts and circumstances don’t. Thus, a benefit of a “real” common law evolution is that it produces a body of law and analysis that actors can use to determine what conduct they can undertake without risk of liability and what they cannot. 

In the abstract, of course, the FTC’s data security process is neither evolutionary in nature nor does it produce such well-defined rules. Rather, it is a succession of wholly independent cases, without any precedent, narrow in scope, and binding only on the parties to each particular case. Moreover it is generally devoid of analysis of the causal link between conduct and liability and entirely devoid of analysis of which facts do not lead to liability. Like all regulation it tends to be static; the FTC is, after all, an enforcement agency, charged with enforcing the strictures of specific and little-changing pieces of legislation and regulation. For better or worse, much of the FTC’s data security adjudication adheres unerringly to the terms of the regulations it enforces with vanishingly little in the way of gloss or evolution. As such (and, we believe, for worse), the FTC’s process in data security cases tends to reject the ever-evolving “local knowledge” of individual actors and substitutes instead the inherently limited legislative and regulatory pronouncements of the past. 

By contrast, real common law, as a result of its case-by-case, bottom-up process, adapts to changing attributes of society over time, largely absent the knowledge and rent-seeking problems of legislatures or administrative agencies. The mechanism of constant litigation of inefficient rules allows the common law to retain a generally efficient character unmatched by legislation, regulation, or even administrative enforcement. 

Because the common law process depends on the issues selected for litigation and the effects of the decisions resulting from that litigation, both the process by which disputes come to the decision-makers’ attention, as well as (to a lesser extent, because errors will be corrected over time) the incentives and ability of the decision-maker to render welfare-enhancing decisions, determine the value of the common law process. These are decidedly problematic at the FTC.

In our analysis, we found the FTC’s process to be wanting compared to the institution of the common law. The incentives of the administrative complaint process put a relatively larger pressure on companies to settle data security actions brought by the FTC compared to private litigants. This is because the FTC can use its investigatory powers as a public enforcer to bypass the normal discovery process to which private litigants are subject, and over which independent judges have authority. 

In a private court action, plaintiffs can’t engage in discovery unless their complaint survives a motion to dismiss from the defendant. Discovery costs remain a major driver of settlements, so this important judicial review is necessary to make sure there is actually a harm present before putting those costs on defendants. 

Furthermore, the FTC can also bring cases in a Part III adjudicatory process which starts in front of an administrative law judge (ALJ) but is then appealable to the FTC itself. Former Commissioner Joshua Wright noted in 2013 that “in the past nearly twenty years… after the administrative decision was appealed to the Commission, the Commission ruled in favor of FTC staff. In other words, in 100 percent of cases where the ALJ ruled in favor of the FTC, the Commission affirmed; and in 100 percent of the cases in which the ALJ ruled against the FTC, the Commission reversed.” In other words, the FTC nearly always rules in favor of itself on appeal if the ALJ finds there is no case, as it did in LabMD. The combination of investigation costs before any complaint at all and the high likelihood of losing through several stages of litigation makes the intelligent business decision to simply agree to a consent decree.

The results of this asymmetrical process show the FTC has not really been building a common law. In all but two cases (Wyndham and LabMD), the companies who have been targeted for investigation by the FTC on data security enforcement have settled. We also noted how the FTC’s data security orders tended to be nearly identical from case-to-case, reflecting the standards of the FTC’s Safeguards Rule. Since the orders were giving nearly identical—and as LabMD found, vague—remedies in each case, it cannot be said there was a common law developing over time.  

What LabMD addressed and what it didn’t

In its decision, the Eleventh Circuit sidestepped fundamental substantive problems with the FTC’s data security practice (which we have made in both our scholarship and LabMD amicus brief) about notice or substantial injury. Instead, the court decided to assume the FTC had proven its case and focused exclusively on the remedy. 

We will assume arguendo that the Commission is correct and that LabMD’s negligent failure to design and maintain a reasonable data-security program invaded consumers’ right of privacy and thus constituted an unfair act or practice.

What the Eleventh Circuit did address, though, was that the remedies the FTC had been routinely applying to businesses through its data enforcement actions lacked the necessary specificity in order to be enforceable through injunctions or cease and desist orders.

In the case at hand, the cease and desist order contains no prohibitions. It does not instruct LabMD to stop committing a specific act or practice. Rather, it commands LabMD to overhaul and replace its data-security program to meet an indeterminable standard of reasonableness. This command is unenforceable. Its unenforceability is made clear if we imagine what would take place if the Commission sought the order’s enforcement…

The Commission moves the district court for an order requiring LabMD to show cause why it should not be held in contempt for violating the following injunctive provision:

[T]he respondent shall … establish and implement, and thereafter maintain, a comprehensive information security program that is reasonably designed to protect the security, confidentiality, and integrity of personal information collected from or about consumers…. Such program… shall contain administrative, technical, and physical safeguards appropriate to respondent’s size and complexity, the nature and scope of respondent’s activities, and the sensitivity of the personal information collected from or about consumers….

The Commission’s motion alleges that LabMD’s program failed to implement “x” and is therefore not “reasonably designed.” The court concludes that the Commission’s alleged failure is within the provision’s language and orders LabMD to show cause why it should not be held in contempt.

At the show cause hearing, LabMD calls an expert who testifies that the data-security program LabMD implemented complies with the injunctive provision at issue. The expert testifies that “x” is not a necessary component of a reasonably designed data-security program. The Commission, in response, calls an expert who disagrees. At this point, the district court undertakes to determine which of the two equally qualified experts correctly read the injunctive provision. Nothing in the provision, however, indicates which expert is correct. The provision contains no mention of “x” and is devoid of any meaningful standard informing the court of what constitutes a “reasonably designed” data-security program. The court therefore has no choice but to conclude that the Commission has not proven — and indeed cannot prove — LabMD’s alleged violation by clear and convincing evidence.

In other words, the Eleventh Circuit found that an order requiring a reasonable data security program is not specific enough to make it enforceable. This leaves questions as to whether the FTC’s requirement of a “reasonable data security program” is specific enough to survive a motion to dismiss and/or a fair notice challenge going forward.

Under the Federal Rules of Civil Procedure, a plaintiff must provide “a short and plain statement . . . showing that the pleader is entitled to relief,” Fed. R. Civ. P. 8(a)(2), including “enough facts to state a claim . . . that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). “[T]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements” will not suffice. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). In FTC v. D-Link, for instance, the Northern District of California dismissed the unfairness claims because the FTC did not sufficiently plead injury. 

[T]hey make out a mere possibility of injury at best. The FTC does not identify a single incident where a consumer’s financial, medical or other sensitive personal information has been accessed, exposed or misused in any way, or whose IP camera has been compromised by unauthorized parties, or who has suffered any harm or even simple annoyance and inconvenience from the alleged security flaws in the DLS devices. The absence of any concrete facts makes it just as possible that DLS’s devices are not likely to substantially harm consumers, and the FTC cannot rely on wholly conclusory allegations about potential injury to tilt the balance in its favor. 

The fair notice question wasn’t reached in LabMD, though it was in FTC v. Wyndham. But the Third Circuit did not analyze the FTC’s data security regime under the “ascertainable certainty” standard applied to agency interpretation of a statute.

Wyndham’s position is unmistakable: the FTC has not yet declared that cybersecurity practices can be unfair; there is no relevant FTC rule, adjudication or document that merits deference; and the FTC is asking the federal courts to interpret § 45(a) in the first instance to decide whether it prohibits the alleged conduct here. The implication of this position is similarly clear: if the federal courts are to decide whether Wyndham’s conduct was unfair in the first instance under the statute without deferring to any FTC interpretation, then this case involves ordinary judicial interpretation of a civil statute, and the ascertainable certainty standard does not apply. The relevant question is not whether Wyndham had fair notice of the FTC’s interpretation of the statute, but whether Wyndham had fair notice of what the statute itself requires.

In other words, Wyndham boxed itself into a corner arguing that they did not have fair notice that the FTC could bring a data security enforcement action against the under Section 5 unfairness. LabMD, on the other hand, argued they did not have fair notice as to how the FTC would enforce its data security standards. Cf. ICLE-Techfreedom Amicus Brief at 19. The Third Circuit even suggested that under an “ascertainable certainty” standard, the FTC failed to provide fair notice: “we agree with Wyndham that the guidebook could not, on its own, provide ‘ascertainable certainty’ of the FTC’s interpretation of what specific cybersecurity practices fail § 45(n).” Wyndham, 799 F.3d at 256 n.21

Most importantly, the Eleventh Circuit did not actually get to the issue of whether LabMD actually violated the law under the factual record developed in the case. This means there is still no caselaw (aside from the ALJ decision in this case) which would allow a company to learn what is and what is not reasonable data security, or what counts as a substantial injury for the purposes of Section 5 unfairness in data security cases. 

How FTC’s changes fundamentally fail to address its failures of process

The FTC’s new approach to its orders is billed as directly responsive to what the Eleventh Circuit did reach in the LabMD decision, but it leaves so much of what makes the process insufficient in place.

First, it is notable that while the FTC highlights changes to its orders, there is still a lack of legal analysis in the orders that would allow a company to accurately predict whether its data security practices are enough under the law. A listing of what specific companies under consent orders are required to do is helpful. But these consent decrees do not require companies to admit liability or contain anything close to the reasoning that accompanies court opinions or normal agency guidance on complying with the law. 

For instance, the general formulation in these 2019 orders is that the company must “establish, implement, and maintain a comprehensive information/software security program that is designed to protect the security, confidentiality, and integrity of such personal information. To satisfy this requirement, Respondent/Defendant must, at a minimum…” (emphasis added), followed by a list of pretty similar requirements with variation depending on the business. Even if a company does all of the listed requirements but a breach occurs, the FTC is not obligated to find the data security program was legally sufficient. There is no safe harbor or presumptive reasonableness that attaches even for the business subject to the order, nonetheless companies looking for guidance. 

While the FTC does now require more specific things, like “yearly employee training, access controls, monitoring systems for data security incidents, patch management systems, and encryption,” there is still no analysis on how to meet the standard of reasonableness the FTC relies upon. In other words, it is not clear that this new approach to orders does anything to increase fair notice to companies as to what the FTC requires under Section 5 unfairness.

Second, nothing about the underlying process has really changed. The FTC can still investigate and prosecute cases through administrative law courts with itself as initial court of appeal. This makes the FTC the police, prosecutor, and judge in its own case. In the case of LabMD, who actually won after many appeals, this process ended in bankruptcy. It is no surprise that since the LabMD decision, each of the FTC’s data security enforcement cases have been settled with consent orders, just as they were before the Eleventh Circuit opinion. 

Unfortunately, if the FTC really wants to evolve its data security process like the common law, it needs to engage in an actual common law process. Without caselaw on the facts necessary to establish substantial injury, “unreasonable” data security practices, and causation, there will continue to be more questions than answers about what the law requires. And without changes to the process, the FTC will continue to be able to strong-arm companies into consent decrees.