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As the Federal Communications (FCC) prepares to revoke its economically harmful “net neutrality” order and replace it with a free market-oriented “Restoring Internet Freedom Order,” the FCC and the Federal Trade Commission (FTC) commendably have announced a joint policy for cooperation on online consumer protection.  According to a December 11 FTC press release:

The Federal Trade Commission and Federal Communications Commission (FCC) announced their intent to enter into a Memorandum of Understanding (MOU) under which the two agencies would coordinate online consumer protection efforts following the adoption of the Restoring Internet Freedom Order.

“The Memorandum of Understanding will be a critical benefit for online consumers because it outlines the robust process by which the FCC and FTC will safeguard the public interest,” said FCC Chairman Ajit Pai. “Instead of saddling the Internet with heavy-handed regulations, we will work together to take targeted action against bad actors. This approach protected a free and open Internet for many years prior to the FCC’s 2015 Title II Order and it will once again following the adoption of the Restoring Internet Freedom Order.”

“The FTC is committed to ensuring that Internet service providers live up to the promises they make to consumers,” said Acting FTC Chairman Maureen K. Ohlhausen. “The MOU we are developing with the FCC, in addition to the decades of FTC law enforcement experience in this area, will help us carry out this important work.”

The draft MOU, which is being released today, outlines a number of ways in which the FCC and FTC will work together to protect consumers, including:

The FCC will review informal complaints concerning the compliance of Internet service providers (ISPs) with the disclosure obligations set forth in the new transparency rule. Those obligations include publicly providing information concerning an ISP’s practices with respect to blocking, throttling, paid prioritization, and congestion management. Should an ISP fail to make the required disclosures—either in whole or in part—the FCC will take enforcement action.

The FTC will investigate and take enforcement action as appropriate against ISPs concerning the accuracy of those disclosures, as well as other deceptive or unfair acts or practices involving their broadband services.

The FCC and the FTC will broadly share legal and technical expertise, including the secure sharing of informal complaints regarding the subject matter of the Restoring Internet Freedom Order. The two agencies also will collaborate on consumer and industry outreach and education.

The FCC’s proposed Restoring Internet Freedom Order, which the agency is expected to vote on at its December 14 meeting, would reverse a 2015 agency decision to reclassify broadband Internet access service as a Title II common carrier service. This previous decision stripped the FTC of its authority to protect consumers and promote competition with respect to Internet service providers because the FTC does not have jurisdiction over common carrier activities.

The FCC’s Restoring Internet Freedom Order would return jurisdiction to the FTC to police the conduct of ISPs, including with respect to their privacy practices. Once adopted, the order will also require broadband Internet access service providers to disclose their network management practices, performance, and commercial terms of service. As the nation’s top consumer protection agency, the FTC will be responsible for holding these providers to the promises they make to consumers.

Particularly noteworthy is the suggestion that the FCC and FTC will work to curb regulatory duplication and competitive empire building – a boon to Internet-related businesses that would be harmed by regulatory excess and uncertainty.  Stay tuned for future developments.

The populists are on the march, and as the 2018 campaign season gets rolling we’re witnessing more examples of political opportunism bolstered by economic illiteracy aimed at increasingly unpopular big tech firms.

The latest example comes in the form of a new investigation of Google opened by Missouri’s Attorney General, Josh Hawley. Mr. Hawley — a Republican who, not coincidentally, is running for Senate in 2018alleges various consumer protection violations and unfair competition practices.

But while Hawley’s investigation may jump start his campaign and help a few vocal Google rivals intent on mobilizing the machinery of the state against the company, it is unlikely to enhance consumer welfare — in Missouri or anywhere else.  

According to the press release issued by the AG’s office:

[T]he investigation will seek to determine if Google has violated the Missouri Merchandising Practices Act—Missouri’s principal consumer-protection statute—and Missouri’s antitrust laws.  

The business practices in question are Google’s collection, use, and disclosure of information about Google users and their online activities; Google’s alleged misappropriation of online content from the websites of its competitors; and Google’s alleged manipulation of search results to preference websites owned by Google and to demote websites that compete with Google.

Mr. Hawley’s justification for his investigation is a flourish of populist rhetoric:

We should not just accept the word of these corporate giants that they have our best interests at heart. We need to make sure that they are actually following the law, we need to make sure that consumers are protected, and we need to hold them accountable.

But Hawley’s “strong” concern is based on tired retreads of the same faulty arguments that Google’s competitors (Yelp chief among them), have been plying for the better part of a decade. In fact, all of his apparent grievances against Google were exhaustively scrutinized by the FTC and ultimately rejected or settled in separate federal investigations in 2012 and 2013.

The antitrust issues

To begin with, AG Hawley references the EU antitrust investigation as evidence that

this is not the first-time Google’s business practices have come into question. In June, the European Union issued Google a record $2.7 billion antitrust fine.

True enough — and yet, misleadingly incomplete. Missing from Hawley’s recitation of Google’s antitrust rap sheet are the following investigations, which were closed without any finding of liability related to Google Search, Android, Google’s advertising practices, etc.:

  • United States FTC, 2013. The FTC found no basis to pursue a case after a two-year investigation: “Challenging Google’s product design decisions in this case would require the Commission — or a court — to second-guess a firm’s product design decisions where plausible procompetitive justifications have been offered, and where those justifications are supported by ample evidence.” The investigation did result in a consent order regarding patent licensing unrelated in any way to search and a voluntary commitment by Google not to engage in certain search-advertising-related conduct.
  • South Korea FTC, 2013. The KFTC cleared Google after a two-year investigation. It opened a new investigation in 2016, but, as I have discussed, “[i]f anything, the economic conditions supporting [the KFTC’s 2013] conclusion have only gotten stronger since.”
  • Canada Competition Bureau, 2016. The CCB closed a three-year long investigation into Google’s search practices without taking any action.

Similar investigations have been closed without findings of liability (or simply lie fallow) in a handful of other countries (e.g., Taiwan and Brazil) and even several states (e.g., Ohio and Texas). In fact, of all the jurisdictions that have investigated Google, only the EU and Russia have actually assessed liability.

As Beth Wilkinson, outside counsel to the FTC during the Google antitrust investigation, noted upon closing the case:

Undoubtedly, Google took aggressive actions to gain advantage over rival search providers. However, the FTC’s mission is to protect competition, and not individual competitors. The evidence did not demonstrate that Google’s actions in this area stifled competition in violation of U.S. law.

The CCB was similarly unequivocal in its dismissal of the very same antitrust claims Missouri’s AG seems intent on pursuing against Google:

The Bureau sought evidence of the harm allegedly caused to market participants in Canada as a result of any alleged preferential treatment of Google’s services. The Bureau did not find adequate evidence to support the conclusion that this conduct has had an exclusionary effect on rivals, or that it has resulted in a substantial lessening or prevention of competition in a market.

Unfortunately, rather than follow the lead of these agencies, Missouri’s investigation appears to have more in common with Russia’s effort to prop up a favored competitor (Yandex) at the expense of consumer welfare.

The Yelp Claim

Take Mr. Hawley’s focus on “Google’s alleged misappropriation of online content from the websites of its competitors,” for example, which cleaves closely to what should become known henceforth as “The Yelp Claim.”

While the sordid history of Yelp’s regulatory crusade against Google is too long to canvas in its entirety here, the primary elements are these:

Once upon a time (in 2005), Google licensed Yelp’s content for inclusion in its local search results. In 2007 Yelp ended the deal. By 2010, and without a license from Yelp (asserting fair use), Google displayed small snippets of Yelp’s reviews that, if clicked on, led to Yelp’s site. Even though Yelp received more user traffic from those links as a result, Yelp complained, and Google removed Yelp snippets from its local results.

In its 2013 agreement with the FTC, Google guaranteed that Yelp could opt-out of having even snippets displayed in local search results by committing Google to:

make available a web-based notice form that provides website owners with the option to opt out from display on Google’s Covered Webpages of content from their website that has been crawled by Google. When a website owner exercises this option, Google will cease displaying crawled content from the domain name designated by the website owner….

The commitments also ensured that websites (like Yelp) that opt out would nevertheless remain in Google’s general index.

Ironically, Yelp now claims in a recent study that Google should show not only snippets of Yelp reviews, but even more of Yelp’s content. (For those interested, my colleagues and I have a paper explaining why the study’s claims are spurious).

The key bit here, of course, is that Google stopped pulling content from Yelp’s pages to use in its local search results, and that it implemented a simple mechanism for any other site wishing to opt out of the practice to do so.

It’s difficult to imagine why Missouri’s citizens might require more than this to redress alleged anticompetitive harms arising from the practice.

Perhaps AG Hawley thinks consumers would be better served by an opt-in mechanism? Of course, this is absurd, particularly if any of Missouri’s citizens — and their businesses — have websites. Most websites want at least some of their content to appear on Google’s search results pages as prominently as possible — see this and this, for example — and making this information more accessible to users is why Google exists.

To be sure, some websites may take issue with how much of their content Google features and where it places that content. But the easy opt out enables them to prevent Google from showing their content in a manner they disapprove of. Yelp is an outlier in this regard because it views Google as a direct competitor, especially to the extent it enables users to read some of Yelp’s reviews without visiting Yelp’s pages.

For Yelp and a few similarly situated companies the opt out suffices. But for almost everyone else the opt out is presumably rarely exercised, and any more-burdensome requirement would just impose unnecessary costs, harming instead of helping their websites.

The privacy issues

The Missouri investigation also applies to “Google’s collection, use, and disclosure of information about Google users and their online activities.” More pointedly, Hawley claims that “Google may be collecting more information from users than the company was telling consumers….”

Presumably this would come as news to the FTC, which, with a much larger staff and far greater expertise, currently has Google under a 20 year consent order (with some 15 years left to go) governing its privacy disclosures and information-sharing practices, thus ensuring that the agency engages in continual — and well-informed — oversight of precisely these issues.

The FTC’s consent order with Google (the result of an investigation into conduct involving Google’s short-lived Buzz social network, allegedly in violation of Google’s privacy policies), requires the company to:

  • “[N]ot misrepresent in any manner, expressly or by implication… the extent to which respondent maintains and protects the privacy and confidentiality of any [user] information…”;
  • “Obtain express affirmative consent from” users “prior to any new or additional sharing… of the Google user’s identified information with any third party” if doing so would in any way deviate from previously disclosed practices;
  • “[E]stablish and implement, and thereafter maintain, a comprehensive privacy program that is reasonably designed to [] address privacy risks related to the development and management of new and existing products and services for consumers, and (2) protect the privacy and confidentiality of [users’] information”; and
  • Along with a laundry list of other reporting requirements, “[submit] biennial assessments and reports [] from a qualified, objective, independent third-party professional…, approved by the [FTC] Associate Director for Enforcement, Bureau of Consumer Protection… in his or her sole discretion.”

What, beyond the incredibly broad scope of the FTC’s consent order, could the Missouri AG’s office possibly hope to obtain from an investigation?

Google is already expressly required to provide privacy reports to the FTC every two years. It must provide several of the items Hawley demands in his CID to the FTC; others are required to be made available to the FTC upon demand. What materials could the Missouri AG collect beyond those the FTC already receives, or has the authority to demand, under its consent order?

And what manpower and expertise could Hawley apply to those materials that would even begin to equal, let alone exceed, those of the FTC?

Lest anyone think the FTC is falling down on the job, a year after it issued that original consent order the Commission fined Google $22.5 million for violating the order in a questionable decision that was signed on to by all of the FTC’s Commissioners (both Republican and Democrat) — except the one who thought it didn’t go far enough.

That penalty is of undeniable import, not only for its amount (at the time it was the largest in FTC history) and for stemming from alleged problems completely unrelated to the issue underlying the initial action, but also because it was so easy to obtain. Having put Google under a 20-year consent order, the FTC need only prove (or threaten to prove) contempt of the consent order, rather than the specific elements of a new violation of the FTC Act, to bring the company to heel. The former is far easier to prove, and comes with the ability to impose (significant) damages.

So what’s really going on in Jefferson City?

While states are, of course, free to enforce their own consumer protection laws to protect their citizens, there is little to be gained — other than cold hard cash, perhaps — from pursuing cases that, at best, duplicate enforcement efforts already undertaken by the federal government (to say nothing of innumerable other jurisdictions).

To take just one relevant example, in 2013 — almost a year to the day following the court’s approval of the settlement in the FTC’s case alleging Google’s violation of the Buzz consent order — 37 states plus DC (not including Missouri) settled their own, follow-on litigation against Google on the same facts. Significantly, the terms of the settlement did not impose upon Google any obligation not already a part of the Buzz consent order or the subsequent FTC settlement — but it did require Google to fork over an additional $17 million.  

Not only is there little to be gained from yet another ill-conceived antitrust campaign, there is much to be lost. Such massive investigations require substantial resources to conduct, and the opportunity cost of doing so may mean real consumer issues go unaddressed. The Consumer Protection Section of the Missouri AG’s office says it receives some 100,000 consumer complaints a year. How many of those will have to be put on the back burner to accommodate an investigation like this one?

Even when not politically motivated, state enforcement of CPAs is not an unalloyed good. In fact, empirical studies of state consumer protection actions like the one contemplated by Mr. Hawley have shown that such actions tend toward overreach — good for lawyers, perhaps, but expensive for taxpayers and often detrimental to consumers. According to a recent study by economists James Cooper and Joanna Shepherd:

[I]n recent decades, this thoughtful balance [between protecting consumers and preventing the proliferation of lawsuits that harm both consumers and businesses] has yielded to damaging legislative and judicial overcorrections at the state level with a common theoretical mistake: the assumption that more CPA litigation automatically yields more consumer protection…. [C]ourts and legislatures gradually have abolished many of the procedural and remedial protections designed to cabin state CPAs to their original purpose: providing consumers with redress for actual harm in instances where tort and contract law may provide insufficient remedies. The result has been an explosion in consumer protection litigation, which serves no social function and for which consumers pay indirectly through higher prices and reduced innovation.

AG Hawley’s investigation seems almost tailored to duplicate the FTC’s extensive efforts — and to score political points. Or perhaps Mr. Hawley is just perturbed that Missouri missed out its share of the $17 million multistate settlement in 2013.

Which raises the spectre of a further problem with the Missouri case: “rent extraction.”

It’s no coincidence that Mr. Hawley’s investigation follows closely on the heels of Yelp’s recent letter to the FTC and every state AG (as well as four members of Congress and the EU’s chief competition enforcer, for good measure) alleging that Google had re-started scraping Yelp’s content, thus violating the terms of its voluntary commitments to the FTC.

It’s also no coincidence that Yelp “notified” Google of the problem only by lodging a complaint with every regulator who might listen rather than by actually notifying Google. But an action like the one Missouri is undertaking — not resolution of the issue — is almost certainly exactly what Yelp intended, and AG Hawley is playing right into Yelp’s hands.  

Google, for its part, strongly disputes Yelp’s allegation, and, indeed, has — even according to Yelp — complied fully with Yelp’s request to keep its content off Google Local and other “vertical” search pages since 18 months before Google entered into its commitments with the FTC. Google claims that the recent scraping was inadvertent, and that it would happily have rectified the problem if only Yelp had actually bothered to inform Google.

Indeed, Yelp’s allegations don’t really pass the smell test: That Google would suddenly change its practices now, in violation of its commitments to the FTC and at a time of extraordinarily heightened scrutiny by the media, politicians of all stripes, competitors like Yelp, the FTC, the EU, and a host of other antitrust or consumer protection authorities, strains belief.

But, again, identifying and resolving an actual commercial dispute was likely never the goal. As a recent, fawning New York Times article on “Yelp’s Six-Year Grudge Against Google” highlights (focusing in particular on Luther Lowe, now Yelp’s VP of Public Policy and the author of the letter):

Yelp elevated Mr. Lowe to the new position of director of government affairs, a job that more or less entails flying around the world trying to sic antitrust regulators on Google. Over the next few years, Yelp hired its first lobbyist and started a political action committee. Recently, it has started filing complaints in Brazil.

Missouri, in other words, may just be carrying Yelp’s water.

The one clear lesson of the decades-long Microsoft antitrust saga is that companies that struggle to compete in the market can profitably tax their rivals by instigating antitrust actions against them. As Milton Friedman admonished, decrying “the business community’s suicidal impulse” to invite regulation:

As a believer in the pursuit of self-interest in a competitive capitalist system, I can’t blame a businessman who goes to Washington [or is it Jefferson City?] and tries to get special privileges for his company.… Blame the rest of us for being so foolish as to let him get away with it.

Taking a tough line on Silicon Valley firms in the midst of today’s anti-tech-company populist resurgence may help with the electioneering in Mr. Hawley’s upcoming bid for a US Senate seat and serve Yelp, but it doesn’t offer any clear, actual benefits to Missourians. As I’ve wondered before: “Exactly when will regulators be a little more skeptical of competitors trying to game the antitrust laws for their own advantage?”

The FTC will hold an “Informational Injury Workshop” in December “to examine consumer injury in the context of privacy and data security.” Defining the scope of cognizable harm that may result from the unauthorized use or third-party hacking of consumer information is, to be sure, a crucial inquiry, particularly as ever-more information is stored digitally. But the Commission — rightly — is aiming at more than mere definition. As it notes, the ultimate objective of the workshop is to address questions like:

How do businesses evaluate the benefits, costs, and risks of collecting and using information in light of potential injuries? How do they make tradeoffs? How do they assess the risks of different kinds of data breach? What market and legal incentives do they face, and how do these incentives affect their decisions?

How do consumers perceive and evaluate the benefits, costs, and risks of sharing information in light of potential injuries? What obstacles do they face in conducting such an evaluation? How do they evaluate tradeoffs?

Understanding how businesses and consumers assess the risk and cost “when information about [consumers] is misused,” and how they conform their conduct to that risk, entails understanding not only the scope of the potential harm, but also the extent to which conduct affects the risk of harm. This, in turn, requires an understanding of the FTC’s approach to evaluating liability under Section 5 of the FTC Act.

The problem, as we discuss in comments submitted by the International Center for Law & Economics to the FTC for the workshop, is that the Commission’s current approach troublingly mixes the required separate analyses of risk and harm, with little elucidation of either.

The core of the problem arises from the Commission’s reliance on what it calls a “reasonableness” standard for its evaluation of data security. By its nature, a standard that assigns liability for only unreasonable conduct should incorporate concepts resembling those of a common law negligence analysis — e.g., establishing a standard of due care, determining causation, evaluating the costs of and benefits of conduct that would mitigate the risk of harm, etc. Unfortunately, the Commission’s approach to reasonableness diverges from the rigor of a negligence analysis. In fact, as it has developed, it operates more like a strict liability regime in which largely inscrutable prosecutorial discretion determines which conduct, which firms, and which outcomes will give rise to liability.

Most troublingly, coupled with the Commission’s untenably lax (read: virtually nonexistent) evidentiary standards, the extremely liberal notion of causation embodied in its “reasonableness” approach means that the mere storage of personal information, even absent any data breach, could amount to an unfair practice under the Act — clearly not a “reasonable” result.

The notion that a breach itself can constitute injury will, we hope, be taken up during the workshop. But even if injury is limited to a particular type of breach — say, one in which sensitive, personal information is exposed to a wide swath of people — unless the Commission’s definition of what it means for conduct to be “likely to cause” harm is fixed, it will virtually always be the case that storage of personal information could conceivably lead to the kind of breach that constitutes injury. In other words, better defining the scope of injury does little to cabin the scope of the agency’s discretion when conduct creating any risk of that injury is actionable.

Our comments elaborate on these issues, as well as providing our thoughts on how the subjective nature of informational injuries can fit into Section 5, with a particular focus on the problem of assessing informational injury given evolving social context, and the need for appropriately assessing benefits in any cost-benefit analysis of conduct leading to informational injury.

ICLE’s full comments are available here.

The comments draw upon our article, When ‘Reasonable’ Isn’t: The FTC’s Standard-Less Data Security Standard, forthcoming in the Journal of Law, Economics and Policy.

In her distinguished tenure as a Commissioner and as Acting Chairman of the FTC, Maureen Ohlhausen has done an outstanding job in explaining the tie between robust patent protection and economic growth and innovation (see, for example, her Harvard Journal of Law and Technology article, here).  Her latest public pronouncement on this topic, an October 13 speech entitled “Strong Patent Rights, Strong Economy,” also makes a highly valuable contribution to the patent policy debate.  Ohlhausen’s speech centers on two key points:  “First, strong patent rights are crucial to economic success.  And, second, economically grounded analysis will reveal the right path through thickets of IP [intellectual property] skepticism.”  Ohlhausen concludes with a reaffirmation of the importance of having the United States lead by example on the world stage in defending strong patent rights:

Patents have been at the heart of US innovation since the founding of our country, and respect for patent rights is fundamental to advance innovation.  The United States is more technologically innovative than any other country in the world.  This reality reflects, in part, the property rights that the United States government grants to inventors.  Still, foreign counterparts take or allow the taking of American proprietary technologies without due payment.  For example, emerging competition regimes view “unfairly high royalties” as illegal under antitrust law.  The FTC’s recent policy work offers an important counterweight to this approach, illustrating the important role that patents play in promoting innovation and benefiting consumers.     

In closing, while we may live in an age of patent skepticism, there is hope. Criticism of IP rights frequently does not hold up upon closer examination. Rather, empirical research favors the close tie between strong IP rights and R&D.  This is not to say that changes to the patent system are always unwarranted.  Rather, the key to addressing the U.S. patent system lies in incremental adjustment where necessary based on a firm empirical foundation.  The U.S. economy stands as a shining reminder of everything that American innovation policy has achieved – and intellectual property rights, and patents, are the important cornerstones of those achievements.

Ohlhausen’s remarks are, as always, thoughtful and well worth studying.

I’ll be participating in two excellent antitrust/consumer protection events next week in DC, both of which may be of interest to our readers:

5th Annual Public Policy Conference on the Law & Economics of Privacy and Data Security

hosted by the GMU Law & Economics Center’s Program on Economics & Privacy, in partnership with the Future of Privacy Forum, and the Journal of Law, Economics & Policy.

Conference Description:

Data flows are central to an increasingly large share of the economy. A wide array of products and business models—from the sharing economy and artificial intelligence to autonomous vehicles and embedded medical devices—rely on personal data. Consequently, privacy regulation leaves a large economic footprint. As with any regulatory enterprise, the key to sound data policy is striking a balance between competing interests and norms that leaves consumers better off; finding an approach that addresses privacy concerns, but also supports the benefits of technology is an increasingly complex challenge. Not only is technology continuously advancing, but individual attitudes, expectations, and participation vary greatly. New ideas and approaches to privacy must be identified and developed at the same pace and with the same focus as the technologies they address.

This year’s symposium will include panels on Unfairness under Section 5: Unpacking “Substantial Injury”, Conceptualizing the Benefits and Costs from Data Flows, and The Law and Economics of Data Security.

I will be presenting a draft paper, co-authored with Kristian Stout, on the FTC’s reasonableness standard in data security cases following the Commission decision in LabMD, entitled, When “Reasonable” Isn’t: The FTC’s Standard-less Data Security Standard.

Conference Details:

  • Thursday, June 8, 2017
  • 8:00 am to 3:40 pm
  • at George Mason University, Founders Hall (next door to the Law School)
    • 3351 Fairfax Drive, Arlington, VA 22201

Register here

View the full agenda here

 

The State of Antitrust Enforcement

hosted by the Federalist Society.

Panel Description:

Antitrust policy during much of the Obama Administration was a continuation of the Bush Administration’s minimal involvement in the market. However, at the end of President Obama’s term, there was a significant pivot to investigations and blocks of high profile mergers such as Halliburton-Baker Hughes, Comcast-Time Warner Cable, Staples-Office Depot, Sysco-US Foods, and Aetna-Humana and Anthem-Cigna. How will or should the new Administration analyze proposed mergers, including certain high profile deals like Walgreens-Rite Aid, AT&T-Time Warner, Inc., and DraftKings-FanDuel?

Join us for a lively luncheon panel discussion that will cover these topics and the anticipated future of antitrust enforcement.

Speakers:

  • Albert A. Foer, Founder and Senior Fellow, American Antitrust Institute
  • Profesor Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Honorable Joshua D. Wright, Professor of Law, George Mason University School of Law
  • Moderator: Honorable Ronald A. Cass, Dean Emeritus, Boston University School of Law and President, Cass & Associates, PC

Panel Details:

  • Friday, June 09, 2017
  • 12:00 pm to 2:00 pm
  • at the National Press Club, MWL Conference Rooms
    • 529 14th Street, NW, Washington, DC 20045

Register here

Hope to see everyone at both events!

On February 28, the Heritage Foundation released Prosperity Unleashed:  Smarter Financial Regulation, a Report that lays bare the heavy and unnecessary burdens imposed on our economy by defective financial regulations, and proposed market-oriented regulatory reforms that would benefit American producers, consumers, and the overall economy.  In a recent Truth on the Market blog commentary, I summarized the key findings and recommendations set forth in the Report’s 23 chapters.  In this commentary, I explore in greater detail chapter 19 of the Report, “How Congress Should Protect Consumers’ Finances,” co-authored by George Mason University Foundation Professor of Law Todd J. Zywicki and me.

Chapter 19 makes the case for legislative reform that would eliminate the U.S. Consumer Financial Protection Bureau’s oversight of consumer protection in financial markets and transfer such authority to the U.S. Federal Trade Commission (key excerpts with footnote references omitted follow):

Free-market competition is key to the efficient provision of the goods and services that consumers desire. More generally, the free market promotes innovation and overall economic welfare. Imperfect information can, however, limit the ability of competition to be effective in benefiting consumers and the economy. In particular, inaccurate information about the quality and attributes of market offerings may lead consumers to make mistaken purchase decisions—in other words, consumers may not get what they think they bargained for. This will lead to the distrust of market processes, as sellers find it harder to differentiate themselves from their competition. The end result is less-effective competition, less consumer satisfaction, and lower economic welfare.

Fraudulent or deceptive statements regarding product or service attributes, and negative features of products or services that become evident only after sale, are prime examples of inaccurate information that undermines trust in competitive firms. Accordingly, the government has a legitimate role in seeking to curb fraud, deception, and related informational problems. Historically, the federal government’s primary consumer protection agency, the U.S. Federal Trade Commission (FTC), has taken the lead in bringing enforcement actions against businesses that distort markets by engaging in “deceptive” or “unfair” practices when marketing their offerings to consumers. In recent decades, the FTC has taken an economics-focused approach in these areas. Specifically, it has limited “deception prosecutions” to cases where consumers acting reasonably were misled and tangibly harmed, and “unfairness prosecutions” to situations involving consumer injury not outweighed by countervailing benefits (a cost-benefit approach). In other words, although the FTC may have erred from time to time in specific cases, its general approach has avoided government overreach and has been conducive to enhancing marketplace efficiency and consumer welfare.

However, Congress has not allowed the FTC to exercise economy-wide oversight over consumer protection, in general, and fraud and deception, in particular. For many years, a hodgepodge of different federal financial service regulators were empowered to regulate the practices of a wide variety of financial industry entities, with the FTC only empowered to oversee consumer financial protection with respect to the narrow category of “non-bank financial institutions.” As part of the 2010 Dodd–Frank financial reform legislation, Congress created a new Consumer Financial Protection Bureau (CFPB), loosely tied to the Federal Reserve Board. While Dodd–Frank mandated shared CFPB–FTC consumer protection jurisdiction over non-bank financial institutions, it transferred all other authority over the many separate consumer financial protection laws to the CFPB alone. The CFPB is simultaneously one of the most powerful and least-accountable regulatory bodies in United States history. In marked contrast to the FTC’s economics-based approach, the CFPB intervenes in financial market consumer-related practices in a heavy-handed arbitrary fashion that ignores sound economics. The upshot is that far from improving market efficiency, the CFPB reduces market efficiency, to the detriment of consumers, producers, and the overall economy. In short, the CFPB’s actions are a prime example of government failure.

The substantive powers of the CFPB are vast and ill-defined. The CFPB has power to regulate the terms and marketing of every consumer credit product in the economy. And, because many small businesses use personal credit to start and grow their businesses (such as personal credit cards, home equity lines of credit, and even products like auto title loans), the CFPB possesses substantial control over much of the allocation of small-business credit as well. The CFPB has the power to take enforcement and regulatory action against “unfair, deceptive, and abusive” consumer credit terms, an authority that the CFPB has exercised with gusto. Moreover, the CFPB has deliberately eschewed regulatory rule-making that would clarify these terms, preferring to engage in case-by-case enforcement actions that undermine predictability and chill vigorous competition and innovation. Yet despite the broad authority granted to the CFPB, its appetite is broader still: The CFPB has taken action to regulate products such as cellphone billing, for-profit career colleges, and even loans made by auto dealers (despite express jurisdictional limits in Dodd–Frank regarding the latter).

The consequences of this unchecked authority have been disastrous for consumers and the economy. Complicated rules with high compliance costs have choked off access to mortgages, credit cards, and other financial products. Overwhelmed by the costs and uncertainty of regulatory compliance, small banks have exited traditional lines of business, such as home mortgages, and feared entering new lines, such as small-dollar loans. Consistent with the general effects of Dodd–Frank, the CFPB has contributed to the consolidation of the American financial sector, making big banks bigger, and forcing consolidation of small banks. By imposing one-size-fits-all bureaucratic underwriting standards on community banks and credit unions, the CFPB has deprived these actors of their traditional model of relationship lending and intimate knowledge of their customers—their lone competitive advantage over megabanks.

Perhaps the most tragic element of the CFPB train wreck is the missed opportunity for reform that it represents. At the time of Dodd–Frank, the system of consumer financial protection was badly in need of modernization: The existing system was cumbersome, incoherent, and ineffective. Fragmented among multiple federal agencies with authority over different providers of financial services, the federal system lacked the ability to lay down a coherent regulatory regime that would promote competition, consumer choice, and consumer protection consistent with the realities of a 21st-century economy and technology. While there is little evidence that the financial crisis resulted from a breakdown of consumer financial protection (as opposed to safety and soundness issues), reform was timely. But Dodd–Frank squandered a once-in-a-generation opportunity to bring about real reform.

In this chapter, we briefly make the case that some degree of reform of the consumer financial protection system was appropriate, in particular, the consolidation of consumer financial protection in one federal agency. However, we challenge the apparatus constructed by Dodd–Frank that created a new unaccountable super-regulator with a tunnel vision focus on a narrow definition of “consumer protection.” Instead, we argue that existing substantive powers were largely sufficient to the task of consumer protection, and that Congress could have achieved better results by acting within the existing institutional framework by simply consolidating authority in the FTC. By working within the existing framework of long-standing substantive authorities and institutional arrangements, Congress could have provided the needed modernization of the federal consumer financial protection system without the unintended consequences that have resulted from the creation of the CFPB. . . .

Consolidating the powers granted to the CFPB in the FTC, which still retains certain regulatory responsibilities with respect to consumer finance, would have a number of advantages over the course chosen in Dodd–Frank.

First, the FTC is a multimember, bipartisan commission. This is an important improvement over the structure of the CFPB, which [is led by a single unaccountable director and] is neither an independent commission nor an executive agency. . . . 

[Second,] [t]he FTC [,unlike the CFPB,] is . . . subject to Congress’s appropriations process, an important check on the agency’s actions. . . .

Finally, the FTC has a large Bureau of Economics, staffed with academically trained economists who would be ideally suited to take into account the regulatory economic policy issues, discussed herein, to which the CFPB has paid no heed. This would make it far more likely that agency regulatory decisions affecting consumer credit markets would be taken in light of the effects of agency actions on consumer welfare and the broader economy. . . .

[In conclusion,] [e]liminating the CFPB’s authority over consumer protection in financial services, and transferring such authority to the FTC, would greatly improve the current sorry state of affairs. Admittedly, the FTC is a less-than-perfect agency, and even a multimember-commission structure does not prevent institutional mistakes from being made and repeated by the majority. All in all, however, as an accountable institution, the FTC is far superior to the CFPB. Consolidating this authority with the FTC—where it should have been in the first place—will better allow free markets to promote innovation and overall economic welfare. Strengthening this legal framework to provide a single, clearly defined, properly limited set of rules will facilitate competition among financial firms, thus protecting consumers and providing them with better choices.

The Federal Trade Commission’s (FTC) regrettable January 17 filing of a federal court injunctive action against Qualcomm, in the waning days of the Obama Administration, is a blow to its institutional integrity and well-earned reputation as a top notch competition agency.

Stripping away the semantic gloss, the heart of the FTC’s complaint is that Qualcomm is charging smartphone makers “too much” for licenses needed to practice standardized cellular communications technologies – technologies that Qualcomm developed. This complaint flies in the face of the Supreme Court’s teaching in Verizon v. Trinko that a monopolist has every right to charge monopoly prices and thereby enjoy the full fruits of its legitimately obtained monopoly. But Qualcomm is more than one exceptionally ill-advised example of prosecutorial overreach, that (hopefully) will fail and end up on the scrapheap of unsound federal antitrust initiatives. The Qualcomm complaint undoubtedly will be cited by aggressive foreign competition authorities as showing that American antitrust enforcement now recognizes mere “excessive pricing” as a form of “monopoly abuse” – therefore justifying “excessive pricing” cases that are growing like topsy abroad, especially in East Asia.

Particularly unfortunate is the fact that the Commission chose to authorize the filing by a 2-1 vote, which ignored Commissioner Maureen Ohlhausen’s pithy dissent – a rarity in cases involving the filing of federal lawsuits. Commissioner Ohlhausen’s analysis skewers the legal and economic basis for the FTC’s complaint, and her summary, which includes an outstanding statement of basic antitrust enforcement principles, is well worth noting (footnote omitted):

My practice is not to write dissenting statements when the Commission, against my vote, authorizes litigation. That policy reflects several principles. It preserves the integrity of the agency’s mission, recognizes that reasonable minds can differ, and supports the FTC’s staff, who litigate demanding cases for consumers’ benefit. On the rare occasion when I do write, it has been to avoid implying that I disagree with the complaint’s theory of liability.

I do not depart from that policy lightly. Yet, in the Commission’s 2-1 decision to sue Qualcomm, I face an extraordinary situation: an enforcement action based on a flawed legal theory (including a standalone Section 5 count) that lacks economic and evidentiary support, that was brought on the eve of a new presidential administration, and that, by its mere issuance, will undermine U.S. intellectual property rights in Asia and worldwide. These extreme circumstances compel me to voice my objections.

Let us hope that President Trump makes it an early and high priority to name Commissioner Ohlhausen Acting Chairman of the FTC. The FTC simply cannot afford any more embarrassing and ill-reasoned antitrust initiatives that undermine basic principles of American antitrust enforcement and may be used by foreign competition authorities to justify unwarranted actions against American firms. Maureen Ohlhausen can be counted upon to provide needed leadership in moving the Commission in a sounder direction.

P.S. I have previously published a commentary at this site regarding an unwarranted competition law Statement of Objections directed at Google by the European Commission, a matter which did not involve patent licensing. And for a more general critique of European competition policy along these lines, see here.

As Truth on the Market readers prepare to enjoy their Thanksgiving dinners, let me offer some (hopefully palatable) “food for thought” on a competition policy for the new Trump Administration.  In referring to competition policy, I refer not just to lawsuits directed against private anticompetitive conduct, but more broadly to efforts aimed at curbing government regulatory barriers that undermine the competitive process.

Public regulatory barriers are a huge problem.  Their costs have been highlighted by prestigious international research bodies such as the OECD and World Bank, and considered by the International Competition Network’s Advocacy Working Group.  Government-imposed restrictions on competition benefit powerful incumbents and stymie entry by innovative new competitors.  (One manifestation of this that is particularly harmful for American workers and denies job opportunities to millions of lower-income Americans is occupational licensing, whose increasing burdens are delineated in a substantial body of research – see, for example, a 2015 Obama Administration White House Report and a 2016 Heritage Foundation Commentary that explore the topic.)  Federal Trade Commission (FTC) and Justice Department (DOJ) antitrust officials should consider emphasizing “state action” lawsuits aimed at displacing entry barriers and other unwarranted competitive burdens imposed by self-interested state regulatory boards.  When the legal prerequisites for such enforcement actions are not met, the FTC and the DOJ should ramp up their “competition advocacy” efforts, with the aim of convincing state regulators to avoid adopting new restraints on competition – and, where feasible, eliminating or curbing existing restraints.

The FTC and DOJ also should be authorized by the White House to pursue advocacy initiatives whose goal is to dismantle or lessen the burden of excessive federal regulations (such advocacy played a role in furthering federal regulatory reform during the Ford and Carter Administrations).  To bolster those initiatives, the Trump Administration should consider establishing a high-level federal task force on procompetitive regulatory reform, in the spirit of previous reform initiatives.  The task force would report to the president and include senior level representatives from all federal agencies with regulatory responsibilities.  The task force could examine all major regulatory and statutory schemes overseen by Executive Branch and independent agencies, and develop a list of specific reforms designed to reduce federal regulatory impediments to robust competition.  Those reforms could be implemented through specific regulatory changes or legislative proposals, as the case might require.  The task force would have ample material to work with – for example, anticompetitive cartel-like output restrictions, such as those allowed under federal agricultural orders, are especially pernicious.  In addition to specific cartel-like programs, scores of regulatory regimes administered by individual federal agencies impose huge costs and merit particular attention, as documented in the Heritage Foundation’s annual “Red Tape Rising” reports that document the growing burden of federal regulation (see, for example, the 2016 edition of Red Tape Rising).

With respect to traditional antitrust enforcement, the Trump Administration should emphasize sound, empirically-based economic analysis in merger and non-merger enforcement.  They should also adopt a “decision-theoretic” approach to enforcement, to the greatest extent feasible.  Specifically, in developing their enforcement priorities, in considering case selection criteria, and in assessing possible new (or amended) antitrust guidelines, DOJ and FTC antitrust enforcers should recall that antitrust is, like all administrative systems, inevitably subject to error costs.  Accordingly, Trump Administration enforcers should be mindful of the outstanding insights provide by Judge (and Professor) Frank Easterbrook on the harm from false positives in enforcement (which are more easily corrected by market forces than false negatives), and by Justice (and Professor) Stephen Breyer on the value of bright line rules and safe harbors, supported by sound economic analysis.  As to specifics, the DOJ and FTC should issue clear statements of policy on the great respect that should be accorded the exercise of intellectual property rights, to correct Obama antitrust enforcers’ poor record on intellectual property protection (see, for example, here).  The DOJ and the FTC should also accord greater respect to the efficiencies associated with unilateral conduct by firms possessing market power, and should consider reissuing an updated and revised version of the 2008 DOJ Report on Single Firm Conduct).

With regard to international competition policy, procedural issues should be accorded high priority.  Full and fair consideration by enforcers of all relevant evidence (especially economic evidence) and the views of all concerned parties ensures that sound analysis is brought to bear in enforcement proceedings and, thus, that errors in antitrust enforcement are minimized.  Regrettably, a lack of due process in foreign antitrust enforcement has become a matter of growing concern to the United States, as foreign competition agencies proliferate and increasingly bring actions against American companies.  Thus, the Trump Administration should make due process problems in antitrust a major enforcement priority.  White House-level support (ensuring the backing of other key Executive Branch departments engaged in foreign economic policy) for this priority may be essential, in order to strengthen the U.S. Government’s hand in negotiations and consultations with foreign governments on process-related concerns.

Finally, other international competition policy matters also merit close scrutiny by the new Administration.  These include such issues as the inappropriate imposition of extraterritorial remedies on American companies by foreign competition agencies; the harmful impact of anticompetitive foreign regulations on American businesses; and inappropriate attacks on the legitimate exercise of intellectual property by American firms (in particular, American patent holders).  As in the case of process-related concerns, White House attention and broad U.S. Government involvement in dealing with these problems may be essential.

That’s all for now, folks.  May you all enjoy your turkey and have a blessed Thanksgiving with friends and family.

Next week the FCC is slated to vote on the second iteration of Chairman Wheeler’s proposed broadband privacy rules. Of course, as has become all too common, none of us outside the Commission has actually seen the proposal. But earlier this month Chairman Wheeler released a Fact Sheet that suggests some of the ways it would update the rules he initially proposed.

According to the Fact Sheet, the new proposed rules are

designed to evolve with changing technologies and encourage innovation, and are in harmony with other key privacy frameworks and principles — including those outlined by the Federal Trade Commission and the Administration’s Consumer Privacy Bill of Rights.

Unfortunately, the Chairman’s proposal appears to fall short of the mark on both counts.

As I discuss in detail in a letter filed with the Commission yesterday, despite the Chairman’s rhetoric, the rules described in the Fact Sheet fail to align with the FTC’s approach to privacy regulation embodied in its 2012 Privacy Report in at least two key ways:

  • First, the Fact Sheet significantly expands the scope of information that would be considered “sensitive” beyond that contemplated by the FTC. That, in turn, would impose onerous and unnecessary consumer consent obligations on commonplace uses of data, undermining consumer welfare, depriving consumers of information and access to new products and services, and restricting competition.
  • Second, unlike the FTC’s framework, the proposal described by the Fact Sheet ignores the crucial role of “context” in determining the appropriate level of consumer choice before affected companies may use consumer data. Instead, the Fact Sheet takes a rigid, acontextual approach that would stifle innovation and harm consumers.

The Chairman’s proposal moves far beyond the FTC’s definition of “sensitive” information requiring “opt-in” consent

The FTC’s privacy guidance is, in its design at least, appropriately flexible, aimed at balancing the immense benefits of information flows with sensible consumer protections. Thus it eschews an “inflexible list of specific practices” that would automatically trigger onerous consent obligations and “risk[] undermining companies’ incentives to innovate and develop new products and services….”

Under the FTC’s regime, depending on the context in which it is used (on which see the next section, below), the sensitivity of data delineates the difference between data uses that require “express affirmative” (opt-in) consent and those that do not (requiring only “other protections” short of opt-in consent — e.g., opt-out).

Because the distinction is so important — because opt-in consent is much more likely to staunch data flows — the FTC endeavors to provide guidance as to what data should be considered sensitive, and to cabin the scope of activities requiring opt-in consent. Thus, the FTC explains that “information about children, financial and health information, Social Security numbers, and precise geolocation data [should be treated as] sensitive.” But beyond those instances, the FTC doesn’t consider any other type of data as inherently sensitive.

By contrast, and without explanation, Chairman Wheeler’s Fact Sheet significantly expands what constitutes “sensitive” information requiring “opt-in” consent by adding “web browsing history,” “app usage history,” and “the content of communications” to the list of categories of data deemed sensitive in all cases.

By treating some of the most common and important categories of data as always “sensitive,” and by making the sensitivity of data the sole determinant for opt-in consent, the Chairman’s proposal would make it almost impossible for ISPs to make routine (to say nothing of innovative), appropriate, and productive uses of data comparable to those undertaken by virtually every major Internet company.  This goes well beyond anything contemplated by the FTC — with no evidence of any corresponding benefit to consumers and with obvious harm to competition, innovation, and the overall economy online.

And because the Chairman’s proposal would impose these inappropriate and costly restrictions only on ISPs, it would create a barrier to competition by ISPs in other platform markets, without offering a defensible consumer protection rationale to justify either the disparate treatment or the restriction on competition.

As Fred Cate and Michael Staten have explained,

“Opt-in” offers no greater privacy protection than allowing consumers to “opt-out”…, yet it imposes significantly higher costs on consumers, businesses, and the economy.

Not surprisingly, these costs fall disproportionately on the relatively poor and the less technology-literate. In the former case, opt-in requirements may deter companies from offering services at all, even to people who would make a very different trade-off between privacy and monetary price. In the latter case, because an initial decision to opt-in must be taken in relative ignorance, users without much experience to guide their decisions will face effectively higher decision-making costs than more knowledgeable users.

The Chairman’s proposal ignores the central role of context in the FTC’s privacy framework

In part for these reasons, central to the FTC’s more flexible framework is the establishment of a sort of “safe harbor” for data uses where the benefits clearly exceed the costs and consumer consent may be inferred:

Companies do not need to provide choice before collecting and using consumer data for practices that are consistent with the context of the transaction or the company’s relationship with the consumer….

Thus for many straightforward uses of data, the “context of the transaction,” not the asserted “sensitivity” of the underlying data, is the threshold question in evaluating the need for consumer choice in the FTC’s framework.

Chairman Wheeler’s Fact Sheet, by contrast, ignores this central role of context in its analysis. Instead, it focuses solely on data sensitivity, claiming that doing so is “in line with customer expectations.”

But this is inconsistent with the FTC’s approach.

In fact, the FTC’s framework explicitly rejects a pure “consumer expectations” standard:

Rather than relying solely upon the inherently subjective test of consumer expectations, the… standard focuses on more objective factors related to the consumer’s relationship with a business.

And while everyone agrees that sensitivity is a key part of pegging privacy regulation to actual consumer and corporate relationships, the FTC also recognizes that the importance of the sensitivity of the underlying data varies with the context in which it is used. Or, in the words of the White House’s 2012 Consumer Data Privacy in a Networked World Report (introducing its Consumer Privacy Bill of Rights), “[c]ontext should shape the balance and relative emphasis of particular principles” guiding the regulation of privacy.

By contrast, Chairman Wheeler’s “sensitivity-determines-consumer-expectations” framing is a transparent attempt to claim fealty to the FTC’s (and the Administration’s) privacy standards while actually implementing a privacy regime that is flatly inconsistent with them.

The FTC’s approach isn’t perfect, but that’s no excuse to double down on its failings

The FTC’s privacy guidance, and even more so its privacy enforcement practices under Section 5, are far from perfect. The FTC should be commended for its acknowledgement that consumers’ privacy preferences and companies’ uses of data will change over time, and that there are trade-offs inherent in imposing any constraints on the flow of information. But even the FTC fails to actually assess the magnitude of the costs and benefits of, and the deep complexities involved in, the trade-off, and puts an unjustified thumb on the scale in favor of limiting data use.  

But that’s no excuse for Chairman Wheeler to ignore what the FTC gets right, and to double down on its failings. Based on the Fact Sheet (and the initial NPRM), it’s a virtual certainty that the Chairman’s proposal doesn’t heed the FTC’s refreshing call for humility and flexibility regarding the application of privacy rules to ISPs (and other Internet platforms):

These are complex and rapidly evolving areas, and more work should be done to learn about the practices of all large platform providers, their technical capabilities with respect to consumer data, and their current and expected uses of such data.

The rhetoric of the Chairman’s Fact Sheet is correct: the FCC should in fact conform its approach to privacy to the framework established by the FTC. Unfortunately, the reality of the Fact Sheet simply doesn’t comport with its rhetoric.

As the FCC’s vote on the Chairman’s proposal rapidly nears, and in light of its significant defects, we can only hope that the rest of the Commission refrains from reflexively adopting the proposed regime, and works to ensure that these problematic deviations from the FTC’s framework are addressed before moving forward.

On October 6, 2016, the U.S. Federal Trade Commission (FTC) issued Patent Assertion Entity Activity: An FTC Study (PAE Study), its much-anticipated report on patent assertion entity (PAE) activity.  The PAE Study defined PAEs as follows:

Patent assertion entities (PAEs) are businesses that acquire patents from third parties and seek to generate revenue by asserting them against alleged infringers.  PAEs monetize their patents primarily through licensing negotiations with alleged infringers, infringement litigation, or both. In other words, PAEs do not rely on producing, manufacturing, or selling goods.  When negotiating, a PAE’s objective is to enter into a royalty-bearing or lump-sum license.  When litigating, to generate any revenue, a PAE must either settle with the defendant or ultimately prevail in litigation and obtain relief from the court.

The FTC was mindful of the costs that would be imposed on PAEs, required by compulsory process to respond to the agency’s requests for information.  Accordingly, the FTC obtained information from only 22 PAEs, 18 of which it called “Litigation PAEs” (which “typically sued potential licensees and settled shortly afterward by entering into license agreements with defendants covering small portfolios,” usually yielding total royalties of under $300,000) and 4 of which it dubbed “Portfolio PAEs” (which typically negotiated multimillion dollars licenses covering large portfolios of patents and raised their capital through institutional investors or manufacturing firms).

Furthermore, the FTC’s research was narrowly targeted, not broad-based.  The agency explained that “[o]f all the patents held by PAEs in the FTC’s study, 88% fell under the Computers & Communications or Other Electrical & Electronic technology categories, and more than 75% of the Study PAEs’ overall holdings were software-related patents.”  Consistent with the nature of this sample, the FTC concentrated primarily on a case study of PAE activity in the wireless chipset sector.  The case study revealed that PAEs were more likely to assert their patents through litigation than were wireless manufacturers, and that “30% of Portfolio PAE wireless patent licenses and nearly 90% of Litigation PAE wireless patent licenses resulted from litigation, while only 1% of Wireless Manufacturer wireless patent licenses resulted from litigation.”  But perhaps more striking than what the FTC found was what it did not uncover.  Due to data limitations, “[t]he FTC . . . [did not] attempt[] to determine if the royalties received by Study PAEs were higher or lower than those that the original assignees of the licensed patents could have earned.”  In addition, the case study did “not report how much revenue PAEs shared with others, including independent inventors, or the costs of assertion activity.”

Curiously, the PAE Study also leaped to certain conclusions regarding PAE settlements based on questionable assumptions and without considering legitimate potential incentives for such settlements.  Thus, for example, the FTC found it particularly significant that 77% of litigation PAE settlements were for less than $300,000.  Why?  Because $300,000 was a “de facto benchmark” for nuisance litigation settlements, merely based on one American Intellectual Property Law Association study that claimed defending a non-practicing entity patent lawsuit through the end of discovery costs between $300,000 and $2.5 million, depending on the amount in controversy.  In light of that one study, the FTC surmised “that discovery costs, and not the technological value of the patent, may set the benchmark for settlement value in Litigation PAE cases.”  Thus, according to the FTC, “the behavior of Litigation PAEs is consistent with nuisance litigation.”  As noted patent lawyer Gene Quinn has pointed out, however, the FTC ignored the alternative eminently logical possibility that many settlements for less than $300,000 merely represented reasonable valuations of the patent rights at issue.  Quinn pithily stated:

[T]he reality is the FTC doesn’t know enough about the industry to understand that $300,000 is an arbitrary line in the sand that holds no relevance in the real world. For the very same reason that they said the term “patent troll” is unhelpful (i.e., because it inappropriately discriminates against rights owners without understanding the business model and practices), so too is $300,000 equally unhelpful. Without any understanding or appreciation of the value of the core innovation subject to the license there is no way to know whether a license is being offered for nuisance value or whether it is being offered at full, fair and appropriate value to compensate the patent owner for the infringement they had to chase down in litigation.

I thought the FTC was charged with ensuring fair business practices? It seems what they are doing is radically discriminating against incremental innovations valued at less than $300,000 and actually encouraging patent owners to charge more for their licenses than they are worth so they don’t get labeled a nuisance. Talk about perverse incentives! The FTC should stick to areas where they have subject matter competence and leave these patent issues to the experts.     

In sum, the FTC found that in one particular specialized industry sector featuring a certain  category of patents (software patents), PAEs tended to sue more than manufacturers before agreeing to licensing terms – hardly a surprising finding or a sign of a problem.  (To the contrary, the existence of “substantial” PAE litigation that led to licenses might be a sign that PAEs were acting as efficient intermediaries representing the interests and effectively vindicating the rights of small patentees.)  The FTC was not, however, able to comment on the relative levels of royalties, the extent to which PAE revenues were distributed to inventors, or the costs of PAE litigation (as opposed to any other sort of litigation).  Additionally, the FTC made certain assumptions about certain PAE litigation settlements that ignored reasonable alternative explanations for the behavior that was observed.  Accordingly, the reasonable observer would conclude from this that the agency was (to say the least) in no position to make any sort of policy recommendations, given the absence of any hard evidence of PAE abuses or excessive waste from litigation.

Unfortunately, the reasonable observer would be mistaken.  The FTC recommended reforms to: (1) address discovery burden and “cost asymmetries” (the notion that PAEs are less subject to costly counterclaims because they are not producers) in PAE litigation; (2) provide the courts and defendants with more information about the plaintiffs that have filed infringement lawsuits; (3) streamline multiple cases brought against defendants on the same theories of infringement; and (4) provide sufficient notice of these infringement theories as courts continue to develop heightened pleading requirements for patent cases.

Without getting into the merits of these individual suggestions (and without in any way denigrating the hard work and dedication of the highly talented FTC staffers who drafted the PAE Study), it is sufficient to note that they bear no logical relationship to the factual findings of the report.  The recommendations, which closely echo certain elements of various “patent reform” legislative proposals that have been floated in recent years, could have been advanced before any data had been gathered – with a saving to the companies that had to respond.  In short, the recommendations are classic pre-baked “solutions” to problems that have long been hypothesized.  Advancing such recommendations based on discrete information regarding a small skewed sample of PAEs – without obtaining crucial information on the direct costs and benefits of the PAE transactions being observed, or the incentive effects of PAE activity – is at odds with the FTC’s proud tradition of empirical research.  Unfortunately, Devin Hartline of the Antonin Scalia Law School proved prescient when commenting last April on the possible problems with the PAE Report, based on what was known about it prior to its release (and based on the preliminary thoughts of noted economists and law professors):

While the FTC study may generate interesting information about a handful of firms, it won’t tell us much about how PAEs affect competition and innovation in general.  The study is simply not designed to do this.  It instead is a fact-finding mission, the results of which could guide future missions.  Such empirical research can be valuable, but it’s very important to recognize the limited utility of the information being collected.  And it’s crucial not to draw policy conclusions from it.  Unfortunately, if the comments of some of the Commissioners and supporters of the study are any indication, many critics have already made up their minds about the net effects of PAEs, and they will likely use the study to perpetuate the biased anti-patent fervor that has captured so much attention in recent years.

To the extent patent reform is warranted, it should be considered carefully in a measured fashion, with full consideration given to the costs, benefits, and potential unintended consequences of suggested changes to the patent system and to litigation procedures.  As John Malcolm and I explained in a 2015 Heritage Foundation Legal Backgrounder which explored the relative merits of individual proposed reforms:

Before deciding to take action, Congress should weigh the particular merits of individual reform proposals carefully and meticulously, taking into account their possible harmful effects as well as their intended benefits. Precipitous, unreflective action on legislation is unwarranted, and caution should be the byword, especially since the effects of 2011 legislative changes and recent Supreme Court decisions have not yet been fully absorbed. Taking time is key to avoiding the serious and costly errors that too often are the fruit of omnibus legislative efforts.

Notably, this Legal Backgrounder also noted potential beneficial aspects of PAE activity that were not reflected in the PAE Study:

[E]ven entities whose business model relies on purchasing patents and licensing them or suing those who refuse to enter into licensing agreements and infringe those patents can serve a useful—even a vital—purpose. Some infringers may be large companies that infringe the patents of smaller companies or individual inventors, banking on the fact that such a small-time inventor will be less likely to file a lawsuit against a well-financed entity. Patent aggregators, often backed by well-heeled investors, help to level the playing field and can prevent such abuses.

More important, patent aggregators facilitate an efficient division of labor between inventors and those who wish to use those inventions for the betterment of their fellow man, allowing inventors to spend their time doing what they do best: inventing. Patent aggregators can expand access to patent pools that allow third parties to deal with one vendor instead of many, provide much-needed capital to inventors, and lead to a variety of licensing and sublicensing agreements that create and reflect a valuable and vibrant marketplace for patent holders and provide the kinds of incentives that spur innovation. They can also aggregate patents for litigation purposes, purchasing patents and licensing them in bundles.

This has at least two advantages: It can reduce the transaction costs for licensing multiple patents, and it can help to outsource and centralize patent litigation for multiple patent holders, thereby decreasing the costs associated with such litigation. In the copyright space, the American Society of Composers, Authors, and Publishers (ASCAP) plays a similar role.

All of this is to say that there can be good patent assertion entities that seek licensing agreements and file claims to enforce legitimate patents and bad patent assertion entities that purchase broad and vague patents and make absurd demands to extort license payments or settlements. The proper way to address patent trolls, therefore, is by using the same means and methods that would likely work against ambulance chasers or other bad actors who exist in other areas of the law, such as medical malpractice, securities fraud, and product liability—individuals who gin up or grossly exaggerate alleged injuries and then make unreasonable demands to extort settlements up to and including filing frivolous lawsuits.

In conclusion, the FTC would be well advised to avoid putting forth patent reform recommendations based on the findings of the PAE Study.  At the very least, it should explicitly weigh the implications of other research, which explores PAE-related efficiencies and considers all the ramifications of procedural and patent law changes, before seeking to advance any “PAE reform” recommendations.