Archives For Hart–Scott–Rodino Antitrust Improvements Act

In an age of antitrust populism on both ends of the political spectrum, federal and state regulators face considerable pressure to deploy the antitrust laws against firms that have dominant market shares. Yet federal case law makes clear that merely winning the race for a market is an insufficient basis for antitrust liability. Rather, any plaintiff must show that the winner either secured or is maintaining its dominant position through practices that go beyond vigorous competition. Any other principle would inhibit the competitive process that the antitrust laws are designed to promote. Federal judges who enjoy life tenure are far more insulated from outside pressures and therefore more likely to demand evidence of anticompetitive practices as a predicate condition for any determination of antitrust liability.

This separation of powers between the executive branch, which prosecutes alleged infractions of the law, and the judicial branch, which polices the prosecutor, is the simple genius behind the divided system of government generally attributed to the eighteenth-century French thinker, Montesquieu. The practical wisdom of this fundamental principle of political design, which runs throughout the U.S. Constitution, can be observed in full force in the current antitrust landscape, in which the federal courts have acted as a bulwark against several contestable enforcement actions by antitrust regulators.

In three headline cases brought by the Department of Justice or the Federal Trade Commission since 2017, the prosecutorial bench has struck out in court. Under the exacting scrutiny of the judiciary, government litigators failed to present sufficient evidence that a dominant firm had engaged in practices that caused, or were likely to cause, significant anticompetitive effects. In each case, these enforcement actions, applauded by policymakers and commentators who tend to follow “big is bad” intuitions, foundered when assessed in light of judicial precedent, the factual record, and the economic principles embedded in modern antitrust law. An ongoing suit, filed by the FTC this year after more than 18 months since the closing of the targeted acquisition, exhibits similar factual and legal infirmities.

Strike 1: The AT&T/Time-Warner Transaction

In response to the announcement of AT&T’s $85.4 billion acquisition of Time Warner, the DOJ filed suit in 2017 to prevent the formation of a dominant provider in home-video distribution that would purportedly deny competitors access to “must-have” content. As I have observed previously, this theory of the case suffered from two fundamental difficulties. 

First, content is an abundant and renewable resource so it is hard to see how AT&T+TW could meaningfully foreclose competitors’ access to this necessary input. Even in the hypothetical case of potentially “must-have” content, it was unclear whether it would be economically rational for post-acquisition AT&T regularly to deny access to other distributors, given that doing so would imply an immediate and significant loss in licensing revenues without any clearly offsetting future gain in revenues from new subscribers.

Second, home-video distribution is a market lapsing rapidly into obsolescence as content monetization shifts from home-based viewing to a streaming environment in which consumers expect “anywhere, everywhere” access. The blockbuster acquisition was probably best understood as a necessary effort to adapt to this new environment (already populated by several major streaming platforms), rather than an otherwise puzzling strategy to spend billions to capture a market on the verge of commercial irrelevance. 

Strike 2: The Sabre/Farelogix Acquisition

In 2019, the DOJ filed suit to block the $360 million acquisition of Farelogix by Sabre, one of three leading airline booking platforms, on the ground that it would substantially lessen competition. The factual basis for this legal diagnosis was unclear. In 2018, Sabre earned approximately $3.9 billion in worldwide revenues, compared to $40 million for Farelogix. Given this drastic difference in market share, and the almost trivial share attributable to Farelogix, it is difficult to fathom how the DOJ could credibly assert that the acquisition “would extinguish a crucial constraint on Sabre’s market power.” 

To use a now much-discussed theory of antitrust liability, it might nonetheless be argued that Farelogix posed a “nascent” competitive threat to the Sabre platform. That is: while Farelogix is small today, it may become big enough tomorrow to pose a threat to Sabre’s market leadership. 

But that theory runs straight into a highly inconvenient fact. Farelogix was founded in 1998 and, during the ensuing two decades, had neither achieved broad adoption of its customized booking technology nor succeeded in offering airlines a viable pathway to bypass the three major intermediary platforms. The proposed acquisition therefore seems best understood as a mutually beneficial transaction in which a smaller (and not very nascent) firm elects to monetize its technology by embedding it in a leading platform that seeks to innovate by acquisition. Robust technology ecosystems do this all the time, efficiently exploiting the natural complementarities between a smaller firm’s “out of the box” innovation with the capital-intensive infrastructure of an incumbent. (Postscript: While the DOJ lost this case in federal court, Sabre elected in May 2020 not to close following similarly puzzling opposition by British competition regulators.) 

Strike 3: FTC v. Qualcomm

The divergence of theories of anticompetitive risk from market realities is vividly illustrated by the landmark suit filed by the FTC in 2017 against Qualcomm. 

The litigation pursued nothing less than a wholesale reengineering of the IP licensing relationships between innovators and implementers that underlie the global smartphone market. Those relationships principally consist of device-level licenses between IP innovators such as Qualcomm and device manufacturers and distributors such as Apple. This structure efficiently collects remuneration from the downstream segment of the supply chain for upstream firms that invest in pushing forward the technology frontier. The FTC thought otherwise and pursued a remedy that would have required Qualcomm to offer licenses to its direct competitors in the chip market and to rewrite its existing licenses with device producers and other intermediate users on a component, rather than device, level. 

Remarkably, these drastic forms of intervention into private-ordering arrangements rested on nothing more than what former FTC Commissioner Maureen Ohlhausen once appropriately called a “possibility theorem.” The FTC deployed a mostly theoretical argument that Qualcomm had extracted an “unreasonably high” royalty that had potentially discouraged innovation, impeded entry into the chip market, and inflated retail prices for consumers. Yet these claims run contrary to all available empirical evidence, which indicates that the mobile wireless device market has exhibited since its inception declining quality-adjusted prices, increasing output, robust entry into the production market, and continuous innovation. The mismatch between the government’s theory of market failure and the actual record of market success over more than two decades challenges the policy wisdom of disrupting hundreds of existing contractual arrangements between IP licensors and licensees in a thriving market. 

The FTC nonetheless secured from the district court a sweeping order that would have had precisely this disruptive effect, including imposing a “duty to deal” that would have required Qualcomm to license directly its competitors in the chip market. The Ninth Circuit stayed the order and, on August 11, 2020, issued an unqualified reversal, stating that the lower court had erroneously conflated “hypercompetitive” (good) with anticompetitive (bad) conduct and observing that “[t]hroughout its analysis, the district court conflated the desire to maximize profits with an intent to ‘destroy competition itself.’” In unusually direct language, the appellate court also observed (as even the FTC had acknowledged on appeal) that the district court’s ruling was incompatible with the Supreme Court’s ruling in Aspen Skiing Co. v. Aspen Highlands Skiing Corp., which strictly limits the circumstances in which a duty to deal can be imposed. In some cases, it appears that additional levels of judicial review are necessary to protect antitrust law against not only administrative but judicial overreach.

Axon v. FTC

For the most explicit illustration of the interface between Montesquieu’s principle of divided government and the risk posed to antitrust law by cases of prosecutorial excess, we can turn to an unusual and ongoing litigation, Axon v. FTC.

The HSR Act and Post-Consummation Merger Challenges

The HSR Act provides regulators with the opportunity to preemptively challenge acquisitions and related transactions on antitrust grounds prior to those transactions having been consummated. Since its enactment in 1976, this statutory innovation has laudably increased dealmakers’ ability to close transactions with a high level of certainty that regulators would not belatedly seek to “unscramble the egg.” While the HSR Act does not foreclose this contingency since regulatory failure to challenge a transaction only indicates current enforcement intentions, it is probably fair to say that M&A dealmakers generally assume that regulators would reverse course only in exceptional circumstances. In turn, the low prospect of after-the-fact regulatory intervention encourages the efficient use of M&A transactions for the purpose of shifting corporate assets to users that value those assets most highly.

The FTC’s Belated Attack on the Axon/Vievu Acquisition

Dealmakers may be revisiting that understanding in the wake of the FTC’s decision in January 2020 to challenge the acquisition of Vievu by Axon, each being a manufacturer of body-worn camera equipment and related data-management software for law enforcement agencies. The acquisition had closed in May 2018 but had not been reported through HSR since it fell well below the reportable deal threshold. Given a total transaction value of $7 million, the passage of more than 18 months since closing, and the insolvency or near-insolvency of the target company, it is far from obvious that the Axon acquisition posed a material competitive risk that merits unsettling expectations that regulators will typically not challenge a consummated transaction, especially in the case of what is a micro-sized nebula in the M&A universe. 

These concerns are heightened by the fact that the FTC suit relies on a debatably narrow definition of the relevant market (body-camera equipment and related “cloud-based” data management software for police departments in large metropolitan areas, rather than a market that encompassed more generally defined categories of body-worn camera equipment, law enforcement agencies, and data management services). Even within this circumscribed market, there are apparently several companies that offer related technologies and an even larger group that could plausibly enter in response to perceived profit opportunities. Despite this contestable legal position, Axon’s court filing states that the FTC offered to settle the suit on stiff terms: Axon must agree to divest itself of the Vievu assets and to license all of Axon’s pre-transaction intellectual property to the buyer of the Vievu assets. This effectively amounts to an opportunistic use of the antitrust merger laws to engage in post-transaction market reengineering, rather than merely blocking an acquisition to maintain the pre-transaction status quo.

Does the FTC Violate the Separation of Powers?

In a provocative strategy, Axon has gone on the offensive and filed suit in federal district court to challenge on constitutional grounds the long-standing internal administrative proceeding through which the FTC’s antitrust claims are initially adjudicated. Unlike the DOJ, the FTC’s first stop in the litigation process (absent settlement) is not a federal district court but an internal proceeding before an administrative law judge (“ALJ”), whose ruling can then be appealed to the Commission. Axon is effectively arguing that this administrative internalization of the judicial function violates the separation of powers principle as implemented in the U.S. Constitution. 

Writing on a clean slate, Axon’s claim is eminently reasonable. The fact that FTC-paid personnel sit on both sides of the internal adjudicative process as prosecutor (the FTC litigation team) and judge (the ALJ and the Commissioners) locates the executive and judicial functions in the hands of a single administrative entity. (To be clear, the Commission’s rulings are appealable to federal court, albeit at significant cost and delay.) In any event, a court presented with Axon’s claim—as of this writing, the Ninth Circuit (taking the case on appeal by Axon)—is not writing on a clean slate and is most likely reluctant to accept a claim that would trigger challenges to the legality of other similarly structured adjudicative processes at other agencies. Nonetheless, Axon’s argument does raise important concerns as to whether certain elements of the FTC’s adjudicative mechanism (as distinguished from the very existence of that mechanism) could be refined to mitigate the conflicts of interest that arise in its current form.

Conclusion

Antitrust vigilance certainly has its place, but it also has its limits. Given the aspirational language of the antitrust statutes and the largely unlimited structural remedies to which an antitrust litigation can lead, there is an inevitable risk of prosecutorial overreach that can betray the fundamental objective to protect consumer welfare. Applied to the antitrust context, the separation of powers principle mitigates this risk by subjecting enforcement actions to judicial examination, which is in turn disciplined by the constraints of appellate review and stare decisis. A rich body of federal case law implements this review function by anchoring antitrust in a decisionmaking framework that promotes the public’s interest in deterring business practices that endanger the competitive process behind a market-based economy. As illustrated by the recent string of failed antitrust suits, and the ongoing FTC litigation against Axon, that same decisionmaking framework can also protect the competitive process against regulatory practices that pose this same type of risk.

Although it probably flew under almost everyone’s radar, last week Josh issued his first Concurring Statement as an FTC Commissioner.  The statement came in response to a seemingly arcane Notice of Proposed Rulemaking relating to Hart-Scott-Rodino Premerger Notification Rules:

The proposed rules also establish a procedure for the automatic withdrawal of an HSR filing when filings are made with the U.S. Securities and Exchange Commission (SEC) announcing that a transaction has been terminated.

The proposed rulemaking itself isn’t enormously significant, but Josh’s statement lays down a marker that indicates (as anyone could have predicted) that he intends to do everything he can to improve the agency and its process.

The rule, as suggested above, would automatically withdraw an HSR filing whenever transacting parties filed certain notices with the SEC announcing the termination of a deal.  You may recall that the Hertz/Dollar Thrifty deal had been in the works for at least five years when it finally closed.  When Hertz withdrew its tender offer in October 2011, it did not withdraw its HSR filing.  As reported at the time, Hertz withdrew its bid over difficulty securing FTC approval, which had plagued other offers for Thrifty:

In a sign of frustration, Mr. Thompson said that the company had spent some $30 million over the last few years dealing with the barrage of takeover offers.

Obviously, given the difficulty of securing FTC approval and the costs imposed by the uncertainty it created, there was real benefit to Hertz (and perhaps Thrifty, for that matter) from receiving a decision from the FTC without meanwhile tying up the company’s resources, restraining its decision- and deal-making abilities, complicating negotiations and weakening its credit by maintaining a stalled-but-pending merger.  So the deal was withdrawn, but the HSR filing was not.

In August 2012 the parties re-initiated the merger following ongoing consultations by Hertz with the FTC, and, in November 2012 — a full year after the deal was withdrawn (and a year and a half after the HSR filing) — the FTC approved the deal.

But, understandably, FTC staff don’t want to be wasting resources reviewing hypothetical transactions, and so, following on the heels of the Hertz/Dollar Thrifty deal, wrote the proposed rule to ensure that it never happens again.

Except it didn’t happen in Hertz because, after all, the deal was eventually made. According to Josh, in fact, the situation intended to be avoided by the rule has never arisen:

The proposed rulemaking appears to be a solution in search of a problem. The Federal Register notice states that the proposed rules are necessary to prevent the FTC and DOJ from “expend[ing] scarce resources on hypothetical transactions.” Yet, I have not to date been presented with evidence that any of the over 68,000 transactions notified under the HSR rules have required Commission resources to be allocated to a truly hypothetical transaction. Indeed, it would be surprising to see firms incurring the costs and devoting the time and effort associated with antitrust review in the absence of a good faith intent to proceed with their transaction.

This isn’t to say (and Josh doesn’t say) that the proposed rule is a bad idea, just that, given the apparently negligible benefits of the rule, the costs could easily outweigh the benefits.

Which is why Josh’s Statement is important. What Josh is asking for is not that the rule be scrapped, but simply that, before adopting the rule, the FTC weigh its costs and benefits. And as Josh points out, there could indeed be some costs:

The proposed rules, if adopted, could increase the costs of corporate takeovers and thus distort the market for corporate control. Some companies that had complied with or were attempting to comply with a Second Request, for example, could be forced to restart their antitrust review, leading to significant delays and added expenses. The proposed rules could also create incentives for firms to structure their transactions less efficiently and discourage the use of tender offers. Finally, the proposed new rules will disproportionately burden U.S. public companies; the Federal Register notice acknowledges that the new rules will not apply to tender offers for many non-public and foreign companies.

Given these concerns, I hope that interested parties will avail themselves of the opportunity to submit public comments so that the Commission can make an informed decision at the conclusion of this process.

What is surprising is not that Josh suggested that there might be unanticipated costs to such a rule, nor that cost-benefit analysis be applied. Rather, what’s surprising is that the rest of the Commission didn’t sign on. Why is that surprising? Well, because cost-benefit analysis is not only sensible, it’s consistent with the Obama Administration’s stated regulatory approach. Executive Order 13563 requires that:

Each agency must, among other things:  (1) propose or adopt a regulation only upon a reasoned determination that its benefits justify its costs (recognizing that some benefits and costs are difficult to quantify) . . . In applying these principles, each agency is directed to use the best available techniques to quantify anticipated present and future benefits and costs as accurately as possible.

Unfortunately, as Berin Szoka has pointed out,

The FCC, FTC and many other regulatory agencies aren’t required to do cost-benefit analysis at all.  Because these are “independent agencies”—creatures of Congress rather than part of the Executive Branch (like the Department of Justice)—only Congress can impose cost-benefit analysis on agencies.  A bipartisan bill, the Independent Agency Regulatory Analysis Act (S. 3486), would have allowed the President to impose the same kind of cost-benefit analysis on independent regulatory agencies as on Executive Branch agencies, including review by the Office of Information and Regulatory Affairs (OIRA) for “significant” rulemakings (those with $100 million or more in economic impact, that adversely affect sectors of the economy in a material way, or that create “serious inconsistency” with other agencies’ actions). . . . yet the bill has apparently died . . . .

Legislation or not, it is the Commission’s responsibility to ensure that the rules it enacts will actually be beneficial (it is a consumer protection agency, after all). The staff, presumably, did a perfectly fine job writing the rule they were asked to write. Josh’s point is simply that it isn’t clear the rule should be adopted because it isn’t clear that the benefits of doing so would outweigh the costs.

It may have happened before, but I can’t recall an FTC Commissioner laying down the cost-benefit-analysis gauntlet and publicly calling for consistent cost-benefit review at the Commission, even of seemingly innocuous (but often not actually innocuous), technical rules.

This is exactly the sort of thing that those of us who extolled Josh’s appointment hoped for, and I’m delighted to see him pushing this kind of approach right out of the gate.  No doubt he rocked some boats and took some heat for it. Good. That means he’s on the right track.