Archives For section 5

Geoffrey Manne is Lecturer in Law at Lewis & Clark Law School and Executive Director of the International Center for Law & Economics

Josh and Maureen are to be commended for their important contributions to the discussion over the proper scope of the FTC’s Section 5 enforcement authority. I have commented extensively on UMC and Section 5, Josh’s statement, and particularly the problems if UMC enforcement against the use of injunctions to enforce FRAND-encumbered SEPs before (see, for example, here, here and here). I’d like to highlight here a couple of the most important issues from among these comments along with a couple of additional ones.

First, there is really no sensible disagreement over Josh’s harm to competition prong. And to the extent there is disagreement over the proper role for efficiencies, given the existence of compelling arguments that we don’t need Section 5 at all (see, e.g., Joe Sims and James Cooper), what might have seemed like a radical position in Josh’s statement that the FTC enforce UMC only where no efficiencies exist, Josh’s position is actually something of a middle ground. In any case, the first prong of Josh’s statement (the harm to competition requirement) really should attract unanimity, as it essentially has here today, and all of the FTC’s commissioners should come out and say so, even if debate persists over the second prong. This alone would provide an enormous amount of certainty and sense to the FTC’s UMC enforcement decisions.

Second, sensible, predictable guidance is essential. In her recent speech, echoing the fundamental issue laid out so well in Josh’s statement and elaborated on in his accompanying speech, Maureen notes that:

For many decades, the Commission’s exercise of its UMC authority has launched the agency into a sea of uncertainty, much like the agency weathered when using its unfairness authority in the consumer protection area in the 1970s. In issuing our 1980 statement on the concept of “unfair acts or practices” under our consumer protection authority, the Commission acknowledged the uncertainty that had surrounded the concept of unfairness, admitting that “this uncertainty has been honestly troublesome for some businesses and some members of the legal profession.” This characterization just as aptly describes the state of our UMC authority today.

It seems uncontroversial that some guidance is required, and a pseudo-common law of un-adjudicated settlements lacking any doctrinal analysis simply doesn’t provide sufficient grounds to separate the fair from the unfair. (What follows is drawn from our amicus brief in the Wyndham case).

The FTC’s current approach to UMC enforcement denies companies “a reasonable opportunity to know what is prohibited” and thus follow the law. The FTC has previously suggested that its settlements and Congressional testimony offers all the guidance a company would need—see, e.g., here and here, where Chairwoman Ramirez noted that

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

But settlements (and testimony summarizing them) do not in any way constrain the FTC’s subsequent enforcement decisions; they cannot alone be the basis by which the FTC provides guidance on its UMC authority because, unlike published guidelines, they do not purport to lay out general enforcement principles and are not recognized as doing so by courts and the business community. It is impossible to imagine a court faulting the FTC for failure to adhere to a previous settlement, particularly because settlements are not readily generalizable and bind only the parties who agree to them. As we put it in our Wyndham amicus brief:

Even setting aside this basic legal principle, the gradual accretion of these unadjudicated settlements does not solve the vagueness problem: Where guidelines provide cumulative analysis of previous enforcement decisions to establish general principles, these settlements are devoid of doctrinal analysis and offer little more than an infinite regress of unadjudicated assertions.

Rulemaking is generally preferable to case-by-case adjudication as a way to develop agency-enforced law because rulemaking both reduces vagueness and constrains the mischief that unconstrained agency actions may cause. As the Court noted in SEC v. Chenery Corp.,

The function of filling in the interstices of [a statute] should be performed, as much as possible, through this quasi-legislative promulgation of rules to be applied in the future.

Without Article III court decisions developing binding legal principles ,and with no other meaningful form of guidance from the FTC, the law will remain unconstitutionally vague. And the FTC’s approach to enforcement also allows the FTC to act both arbitrarily and discriminatorily—backed by the costly threat of the CID process and Part III adjudication. This means the company faces two practically certain defeats—before the administrative law judge and then the full Commission, each a public relations disaster. The FTC appears to be perfectly willing to use negative media to encourage settlements: The House Oversight Committee is currently investigating whether a series of leaks by FTC staff to media last year were intended to pressure Google to settle the FTC’s antitrust investigation into the company’s business practices.

Third, if the FTC doesn’t act to constrain itself, the courts or Congress will do so, and may do more damage to the FTC’s authority than any self-imposed constraints would.

The power to determine whether the practices of almost any American business are “unfair” methods of competition (particularly if UMC retains the broad reach Tim Wu outlines in his post) makes the FTC uniquely powerful. This power, if it is to be used sensibly, allows the FTC to protect consumers from truly harmful business practices not covered by the FTC’s general consumer protection authority. But without effective enforcement of clear limiting principles, this power may be stretched beyond what Congress intended.

In 1964, the Commission began using its unfairness power to ban business practices that it determined offended “public policy.” Emboldened by vague Supreme Court dicta from Sperry & Hutchinson comparing the agency to a “court of equity,” the Commission set upon a series of rulemakings and enforcement actions so sweeping that the Washington Post dubbed the agency the “National Nanny.” The FTC’s actions eventually prompted Congress to briefly shut down the agency to reinforce the point that it had not intended the agency to operate with such expansive authority. The FTC survived as an institution only because, in 1980, it (unanimously) issued a Policy Statement on Unfairness laying out basic limiting principles to constrain its power and assuring Congress that these principles would be further developed over time—principles that Congress then codified in Section 5(n) of the FTC Act.

And for a time, the Commission used its unfairness power sparingly and carefully, largely out of fear of reawakening Congressional furor. Back in 1980, the FTC itself declared that

The task of identifying unfair trade practices was therefore assigned to the Commission, subject to judicial review, in the expectation that the underlying criteria would evolve and develop over time.

Yet we know little more today than we did in 1980 about how the FTC analyzes each prong of Section 5.

Moreover, courts may not support enforcement given this ambiguity, and in our Wyndham brief we supported Wyndham’s motion to dismiss for exactly this reason (and that was brought under the Commission’s unfairness authority where it even has some guidelines). As we wrote:

Since the problem is a lack of judicial adjudication, it might seem counter-intuitive that the court should dismiss the FTC’s suit on the pleadings. But this is precisely the form of adjudication required: The FTC needs to be told that its complaints do not meet the minimum standards required to establish a violation of Section 5 because otherwise there is little reason to think that the FTC’s complaints will not continue to be the Commission’s primary means of building law (what amounts to “non-law law”). But even if the FTC re-files its unadjudicated complaint to explain its analysis of the prongs of the Unfairness Doctrine, it will not have solved yet another fundamental problem: its failure to provide Wyndham with sufficient guidance ex ante as to what “reasonable” data security practices would be.

The same could be said of the FTC’s UMC enforcement. Section 5(n) applies to UMC, and states that:

The Commission shall have no authority under this section or section 57a of this title to declare unlawful an act or practice on the grounds that such act or practice is unfair unless the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition. In determining whether an act or practice is unfair, the Commission may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations may not serve as a primary basis for such determination.

Finally, applying this to FRAND-encumbered SEPs, as I have previously discussed, is problematic. As Kobayashi and Wright note in discussing the N-Data case,

[T]he truth is that there was little chance the FTC could have prevailed under the more rigorous Section 2 standard that anchors the liability rule to a demanding standard requiring proof of both exclusionary conduct and competitive harm. One must either accept the proposition that the FTC sought Section 5 liability precisely because there was no evidence of consumer harm or that the FTC believed there was evidence of consumer harm but elected to file the Complaint based only upon the Section 5 theory to encourage an expansive application of that Section, a position several Commissioners joining the Majority Statement have taken in recent years. Neither of these interpretations offers much evidence that N-Data is sound as a matter of prosecutorial discretion or antitrust policy.

None of the FTC’s SEP cases has offered anything approaching proof of consumer harm, and this is where any sensible limiting principles must begin—as just about everyone here today seems to agree. Moreover, even if they did adduce evidence of harm, the often-ignored problem of reverse holdup raises precisely the concern about over-enforcement that Josh’s “no efficiencies” prong is meant to address. Holdup may raise consumer prices (although the FTC has not presented evidence of this), but reverse holdup may do as much or more damage.

The use of injunctions to enforce SEPs increases innovation, the willingness to license generally and the willingness to enter into FRAND commitments in particular–all to the likely benefit of consumer welfare. If the FTC interprets its UMC authority in a way that constrains the ability of patent holders to effectively police their patent rights, then less innovation would be expected–to the detriment of consumers as well as businesses. An unfettered UMC authority will systematically curtail these benefits, quite possibly without countervailing positive effects.

And as I noted in a post yesterday, these costs are real. Innovative technology companies are responding to the current SEP enforcement environment exactly as we would expect them to: by avoiding the otherwise-consumer-welfare enhancing standardization process entirely—as statements made at a recent event demonstrate:

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

Section 5 is a particularly problematic piece of this, and sensible limits like those Josh proposes would go a long way toward mitigating the problem—without removing enforcement authority in the face of real competitive harm, which remains available under the Sherman Act.

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

In this posting, I sketch out a sensible limitation to the FTC’s Section 5 authority.   This domain should be narrow, focusing only on harmful conduct that but for the application of Section 5 would remain un-remedied.

As a threshold matter, the FTC explicitly should renounce its reliance on early Section 5 case law like S&H and Brown Shoe and write from a clean slate.  No serious antitrust enforcer today would consider challenging the conduct at issue in these cases, yet, in each of its recent standard-setting cases, the Commission dutifully invokes the language in S&H and Brown Shoe like a sacred talisman that will conjure the authority to act beyond the “letter and spirit of the antitrust laws.”   This dicta, however, comes from seriously outmoded cases. For example, S&H upheld the Commission’s challenge to the practice of preventing unauthorized green-stamp exchanges, and cited approvingly a Section 5 decision from 1934 that condemned the practice of selling penny candy to children in “break and take” packs, because “it tempted children to gamble and compelled those who would successful compete with Keppel to abandon their scruples by similarly tempting children.”[1]  Brown Shoe and S&H were decided in the era of Schwinn and Utah Pie.  Sherman Act case law has moved light years in the direction of economic literacy since then, and the Commission should recognize that had the Supreme Court entertained Section 5 case in the past forty years, precedents like S&H and Brown Shoe likely would have met fates similar to these outmoded cases.

Second, the FTC should not use Section 5 when the conduct at issue is reachable under the Sherman or Clayton Acts.  Section 5 should never be used as a trump card to reduce the Commission’s burden to show a practice is harmful to consumers. If the Commission cannot carry its burden under the Sherman Act, then presumably the conduct is not likely to be a threat to competition.

Third, the Commission must explain how consumers would benefit from expansion of the antitrust laws beyond the current Sherman Act limits.  Again, merely because there is old Supreme Court language blessing an expansive Section 5 does not ipso facto convert Section 5 enforcement beyond the Sherman Act into a welfare-enhancing exercise.  Accordingly, demonstrable consumer harm must be a necessary condition for invoking Section 5 against a particular practice.

Further, to mitigate the possibility of errors, and hence the probability that FTC action is welfare enhancing, the practice in question should be one that is unlikely to generate cognizable efficiencies.  Thus the FTC should limit itself to the type of conduct that would be subject to per se or a “quick look” condemnation – the type of conduct that can be assessed without an elaborate inquiry into market characteristics.  It should avoid using Section 5 to challenge conduct that would require complex balancing.

How would such a standard treat the FTC’s portfolio of Section 5 cases?  First, ITCs involving small firms would remain.  This conduct is not reachable under Sherman Act and is likely to generate substantial consumer harm.  At the same time, the risk of deterring beneficial conduct is minimal, although as one moves from private solicitations to engage in price fixing or market allocation towards public communications and unilateral conduct, the calculus changes.  Relatedly, involving information sharing seems sensible to retain as well.  Like ITCs, this conduct is not reachable under the Sherman Act (assuming sufficiently low market shares), poses a significant threat to competition, and it is hard to justify on efficiency grounds. Of course, the Sherman Section 1 can reach agreements among competitors to exchange competitively sensitive information, so this genre of cases should be limited to instances where an agreement cannot be shown.  Further, as in the ITC case, the FTC needs to tread carefully as the conduct moves further from direct and private exchanges of future competitive actions toward unilateral public announcements of current and past price and output decisions.  Bolstering the case for the use of Section 5 in these cases is that both ITCs and information sharing cases fall under the broad rubric of incipient harms.  Legislative history and subsequent Supreme pronouncements suggest that Congress intended Section 5 to concern itself with incipiency – a concern lacking in the Sherman Act.

The FTC should abandon its use of Section 5 to reach breaches of FRAND commitments.  Although policies that encourage participation in standard setting are likely to be beneficial to consumers, it is not evident that Section 5 is the best – or even a good – vehicle to address these issues.  That hold-up may result in a higher end price for consumers is insufficient to justify use of Section 5.  There are a host of institutions arguably better suited than the FTC to handle these policy issues, including Article III courts, the ITC, the Patent & Trademark Office, Congress, and self-regulatory bodies. As Commissioner Ohlhausen remarked in her dissent in Bosch, the FTC appears to lack “regulatory humility when it usurps the resolution of FRAND disputes from these other fora.

Finally, deceptive conduct in business-to-business relationships – such as that alleged in Intel or Dell– should be left out of the portfolio entirely.  To the extent that deception gives rise to, or helps maintain, monopoly power, it is reachable under Sherman Section 2.  Otherwise, deception should be left to the domain of contract law or business torts.  Further, these practices should not be challenged under UDAP, which should be confined to deception that directly involves consumers.


[1] S&H, 405 U.S. at 242-43 (quoting FTC v. R.F. Keppel & Bro., Inc., 291 U.S. 304 (1934)).

Marina Lao is Professor of Law at Seton Hall University School of Law

FTC Commissioner Josh Wright’s recent issuance of a proposed policy statement on Section 5 of the FTC Act has reignited the debate on the appropriate scope of the agency’s authority to prosecute “unfair methods of competition” as standalone Section 5 violations.  While the Supreme Court has held, consistent with clear congressional intent, that the FTC’s authority under Section 5 extends to conduct that is well beyond the reach of the Sherman and Clayton Acts, its last decision on the issue (S&H) is over four decades old.  Given that antitrust jurisprudence has changed dramatically since, and all three subsequent circuit court decisions (Boise Cascade, OAG, Ethyl) have gone against the FTC, it is questionable whether today’s Supreme Court would give as expansive a reading to the Commission’s enforcement discretion.  In any event, it is unlikely that the agency would attempt to exercise its full enforcement authority under the elusive terms in the old case law.  Under the circumstances, if the FTC intends to continue to invoke the section to bring standalone cases—and I believe it should–it would be helpful to the antitrust community for the agency to develop standards and to articulate an analytical framework for its application.  Commissioner Wright’s proposed policy statement, and Commissioner Maureen Ohlhausen’s comments on it, are invaluable in re-starting the discussion, which I hope will result in guidelines from the Commission at some point.

Under Commissioner Wright’s proposal, an act or practice must satisfy a two-prong test before the Commission may challenge it as an unfair method of competition: it must harm or is likely to harm competition, and it must not generate cognizable efficiencies.  I find the second element somewhat troubling.

The Cognizable Efficiency Screen.  Under Commissioner Wright’s proposal, cognizable efficiencies operate as a safe harbor: the FTC would not be able to challenge conduct as an unfair method of competition if any cognizable efficiency exists, no matter how slight the efficiency and how substantial the anticompetitive effects.  There is no balancing of the efficiencies against the anticompetitive harm at all, as is called for in the rule of reason under the Sherman Act.  Under this interpretation, Section 5 will effectively set a higher, rather than a lower, bar than the Sherman Act, which seems contrary to the common understanding of the relative standards of the relevant laws.  Though Commissioner Wright does include some useful limiting principles on what efficiencies would be deemed cognizable (conduct-specific, verifiable, and not derived from anticompetitive reductions in output or service), one can still probably come up with a plausible efficiency for almost any business conduct.  If this prong of the test is adopted, the section may prove to be of limited use to the FTC in bringing pure unfair methods of competition cases.

I would prefer a consideration of efficiencies on a sliding scale, as is done in merger analysis.  The greater the harm (or likely harm) to competition, and the greater the deviation from “normally acceptable business behavior” (Ethyl), the more efficiencies must be generated to offset the harm and avoid an injunction under Section 5.  The lesser the competitive harm, the fewer the efficiencies required.

Commissioner Wright provides three rationales for his bright-line efficiencies screen: it would clearly distinguish between acceptable business behavior and unfair methods of competition thereby providing certainty to businesses; it would allocate the agency’s scarce resources toward targeting conduct that is most likely to harm consumers; and it would avoid deterrence of welfare-enhancing conduct.  In my view, none of the three rationales is entirely persuasive.

Of course, a bright-line safe harbor always provides more certainty to a firm than a standard that requires balancing, but there is nothing in the nature of Section 5 enforcement that calls for this degree of certainty.  Remedies for violations of Section 5 are typically limited to injunctions; the FTC does not recover treble damages.  Moreover, the FTC Act cannot be enforced by private parties.  Even if private plaintiffs attempt to build a class-action under the Sherman Act based on a Section 5 adjudication, a finding for the FTC in the ALJ proceeding is not given prima facie effect in the private lawsuit.  Moreover, when the FTC is relying on Section 5 to prohibit conduct outside of the Sherman Act, its findings on fully litigated issues have no preclusive effect whatsoever on the same issues in any follow-on Sherman Act litigation that private parties may attempt to bring.  Therefore, enforcement of pure Section 5 cases does not inflict the kinds of burdens on defendants that are associated with Department of Justice prosecutions under the Sherman Act, for which a higher degree of certainty for businesses may be justified given the collateral consequences.  In the context of Section 5 enforcement, which results only in an injunction, it is not clear why a firm is entitled to know with absolute certainty that, no matter how harmful its conduct may be to consumers, it would be acceptable if it has any efficiencies at all.

To the extent that an FTC adjudication carries no unusual consequences for the firm, relative to other litigation, requiring a balancing of the conduct’s efficiencies against its anticompetitive harms does not subject a firm to an intolerable amount of uncertainty.  Even in those commercial settings in which businesses are usually governed by very specific rules, generalized standards do exist. For example, though the Uniform Commercial Code (covering a wide variety of commercial transactions) consists primarily of very specific rules, it also includes a number of well-accepted overarching fairness-based provisions, such as the requirements of good faith and fair dealing, the doctrine of unconscionability, and standards based on commercial course of dealing and trade usage.  These benchmarks clearly provide a less predictable standard to distinguish between permissible and impermissible conduct than the “uncertain” standard of a rule-of-reason balancing of efficiencies and harms.

As to the second rationale–that an efficiencies screen would focus the FTC’s resources on conduct most likely to harm consumers–I question the premise that anticompetitive conduct with some efficiencies is necessarily less harmful than conduct with no efficiencies.  Consider the following two examples: First, assume, as in Commissioner Wright’s Example 6, that Firm A makes an ex ante commitment on licensing to an SSO as a condition for the adoption of its IP as part of the standard; Firm A later sells its patent to Firm B which announces that it will no longer license under those terms.  Assume further that Firm B is able to show some efficiency gain from its breach of its predecessor’s commitment, but the consumer harm from the breach may be substantial.  (Reneging on Firm A’s commitment undermines the integrity of the standard-setting process, which could reduce the incentives to participate in the process or to implement the standard because of concerns of patent hold-ups, and ultimately affect consumers who would lose some of the benefits of interoperability which comes from standard setting.)  Under the proposed efficiency screen, the FTC cannot challenge the conduct, regardless of the magnitude and nature of the consumer harm.

Second, assume, as in Commissioner Wright’s Example 2, that Firm A invites Firm B to fix prices, but Firm B declines.  Assume further that Firms A and B operate in an industry that has a competitive culture with no history of collusion.  Thus, while the invitation to collude meets the harm to competition element of the test, the risk of competitive harm may be relatively small.  Though the invitation to collude has no efficiencies, whereas Firm B’s breach in the preceding example is found to have some efficiencies, the conduct in the preceding example is likely to cause more consumer harm than the invitation to collude under my facts.

Rather than set a categorical rule which allows the FTC to only challenge competitively harmful conduct with zero efficiencies, why not allow the FTC to make a judgment based on the evidence of harms and efficiencies, if any, that is available?

As for the third rationale, while the need to avoid false positives in ambiguous situations is an important consideration, so too is the need to avoid false negatives.  As I’ve suggested earlier, the social cost of a false positive is much smaller in a pure Section 5 case than in a Sherman Act action.  There is no threat of treble damages, or of automatic follow-on class action suits (that usually follow a successful Department of Justice antitrust action) for which the liability finding in the DOJ action would have a prima facie effect.  Even if a practice is erroneously identified as an unfair method of competition under Section 5—e.g., a delivered pricing term that, though anticompetitive, had efficiencies that were insufficiently recognized and, thus, wrongly enjoined–the cost of the false positive would be that the market may be deprived of the enjoined practice, and firms may have to look to an alternative practice.  But that is probably not a major social cost as firms are generally adept at finding substitutes.

Conduct Must Harm Competition:

Anticompetitive Effect as Definition of Harm to Competition.   I agree with Commissioner Wright that conduct challenged under Section 5 must have an anticompetitive effect; that is, “it must harm the competitive process and thereby harm consumers,” (Microsoft); harm to competitors alone will not suffice.  One difficulty lies in defining harm to the “competitive process,” which is susceptible to different interpretations.  To me, injury to the competitive process is different than having an effect on price or output, or even diminished quality.  It is less measurable, and the ultimate effect on consumers less obvious.  What would be considered indicia of harm to the competitive process and what would not?  Today, there are many markets with minimal or no price competition, or where firms compete primarily through creativity or product development.  In these types of markets, a price and output measure would be inappropriate; perhaps any forthcoming Guidelines could provide more guidance in this regard.

Anticompetitive Effect/CausationCausation is often intertwined with the concept of anticompetitive effect.  In deciding section 2 cases, courts have sometimes held that there is no anticompetitive effect unless the plaintiff can demonstrate that, absent the defendant’s conduct, the “bad” market situation would not have occurred.  For example, assume that a firm deceptively fails to disclose its patents in technologies to an SSO and the technologies were subsequently included by the SSO in industry standards.  However, there was an insufficient showing that, but for the firm’s deception, the SSO would not have included the technologies or would have imposed limits on the patent owner’s licensing fees as a condition for inclusion.  In that situation, courts have held that anticompetitive effect was not shown under Section 2 of the Sherman Act (Rambus).  Even assuming that this restrictive analysis of effect/causation is required under Section 2, though I don’t believe it is, it would seem appropriate to relax this requirement in a pure Section 5 case for the reasons that I have discussed: the absence of collateral impact of a Section 5 violation and the limited remedies that the FTC may seek.  It should be sufficient in this situation to show that the deceptive failure to disclose to the SSO the patents underlying the technology under consideration undermined and harmed the standard-setting processes.  And it should be unnecessary for the FTC to demonstrate that the firm’s deception enabled it to either acquire a monopoly or to avoid the imposition of patent licensing fee limits by the SSO.

Examples of Conduct that is Likely to Harm Competition.  I like both broad categories of conduct that Commissioner Wright described as likely to harm competition under Section 5: invitations to collude; and incipient Section 2 violations—conduct “to acquire market power that does not yet arise to the level of monopoly power” required under Section 2.

With respect to the category of incipient Section 2 violations, I would prefer a slightly broader reach to cover situations where a firm with monopoly power in one market uses that power in a second (complementary or collateral) market and causes considerable harm in the collateral market; however, the firm is unlikely to attain a monopoly in the second market but merely seeks to raise its rivals’ costs.  This claim would clearly not constitute a Section 2 violation today.  I believe that it could fit under Commissioner Wright’s second broad category of conduct likely to harm competition, provided that there is good evidence that competitive harm in the collateral market is likely.

Parallel exclusion, described by Professors Scott Hemphill and Tim Wu in a recent article, could constitute an additional broad category of conduct that could be appropriately addressed under Section 5.  As Professors Hemphill and Wu have explained, the economic effects of parallel exclusion by oligopolists are quite similar to that of exclusion by a monopolist.  Yet, neither section 1 nor section 2 of the Sherman Act can reach that conduct: the agreement element is absent, precluding a section 1 violation; and each firm does not have the requisite market share to meet the monopoly power requirement of section 2 though they collectively share a monopoly, thus precluding a section 2 violation.

Thom Lambert is Wall Family Foundation Chair in Corporate Law & Governance and Professor of Law at University of Missouri School of Law

In the last few weeks, two members of the FTC—Commissioners Josh Wright and Maureen Ohlhausen—have staked largely consistent positions on guidelines for implementation of the Commission’s “unfair methods of competition” (UMC) authority.  Their statements make two points that are, in my opinion, no-brainers.  Where the statements conflict, they raise an issue worthy of significant contemplation.  I’ll be interested to hear others’ thoughts on that matter.

First, the no-brainers.

No-Brainer #1:  We Need Guidance on the Scope of the FTC’s UMC Authority.

Ours is a government of laws and not of men.  That means, in the words of F. A. Hayek, “that government in all its actions [must be] bound by rules fixed and announced beforehand—rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one’s individual affairs on the basis of this knowledge.”  According to the classic statement by A.V. Dicey, the “Rule of Law” means “the absolute supremacy or predominance of regular law as opposed to arbitrary power, and excludes the existence of arbitrariness, of prerogative, or even of wide discretionary authority on the part of government.”  As it stands, Section 5’s prohibition of “unfair methods of competition” is so indeterminate and discretionary that it can hardly constitute law.  The text itself is woefully deficient for, as the Second Circuit observed in analyzing the provision, “[t]he term ‘unfair’ is an elusive concept, often depending upon the eye of the beholder.”  Nor has the caselaw on Section 5 developed in way that lets business planners know what they must and must not do to avoid liability.  The sort of guidance Commissioners Wright and Ohlhausen are proposing, then, is badly needed.

No-Brainer #2:  The FTC Should Not Challenge a Practice Under Its UMC Authority Unless Doing So Is Necessary to Avert an Actual or Likely Harm to Competition.

Commissioners Wright and Ohlhausen agree that for the FTC to bring a “stand-alone” Section 5 action (i.e., one not simply alleging behavior that violates the Sherman Act), the challenged practice must result in, or likely result in, significant harm to competition.  Such harm consists of a reduction in overall market output, usually evinced by an increase in price.  It does not result from mere harm to competitors.  Thus, doing a terrible, horrible, no good, very bad thing to your competitor—while perhaps tortious—would not constitute an unfair method of competition if the action did not, and was not likely to, reduce overall market output.

The reason for this requirement, which may sound harsh and extreme to non-antitrusters, is simple:  Business conduct that hurts competitors without reducing overall market output does not usually leave market output unchanged; rather, it usually enhances market output and thereby benefits consumers.  If the FTC seeks to condemn competitor-harming conduct that doesn’t harm competition, it will likely end up hurting consumers.  In the Brown Shoe case, for example, the FTC condemned exclusive dealing by a shoe manufacturer where harm to competition was unrealistic but competitors were injured.  The effect was to shut down more efficient distribution practices and thereby hurt consumers.  If the FTC is to remain a consumer protection agency, it must limit its UMC challenges to acts causing or threatening significant competitive injury.

That brings us to a somewhat difficult policy question.

The Contestable Issue:  How Broad Should the Safe Harbor for Efficiency-Creating Conduct Be?

Commissioner Wright has taken the position that a second prerequisite to a stand-alone UMC challenge should be that the practice at issue lacks any cognizable efficiencies.  Commissioner Ohlhausen, by contrast, would permit a challenge (assuming her other pre-requisites, which are largely subsumed in Commissioner Wright’s first pre-requisite, are satisfied) when the practice at issue either creates no cognizable efficiencies or “results in harm to competition that is disproportionate to its benefits to consumers and to the economic benefits to the defendant, exclusive of the benefits that may accrue from reduced competition.”  Ohlhausen is careful to emphasize that she is not proposing “to balance precisely” procompetitive versus anticompetitive effects.  Instead, the latter prong of her disjunctive pre-requisite is satisfied only if the surplus lost from reduced output significantly outweighs the efficiencies created by the practice.

As a practical matter, the dispute here may reduce to, “What must a firm show to come within a safe harbor from stand-alone UMC liability?”  According to Commissioner Wright, establishing cognizable efficiencies from the practice at issue will keep you safe.  Commissioner Ohlhausen would require a firm to establish such efficiencies and show that they are not significantly outweighed by lost surplus from reduced output.

So whose approach is better?  I’ll confess that I’ve gone back and forth on that question over the last few days.  On the one hand, Commissioner Wright’s position seems awfully pro-defendant: a tiny increase in productive efficiency stemming from a practice could insulate the practice even if it occasioned huge allocative inefficiencies.  Do we really need so expansive a safe harbor here, given that UMC judgments occasion only injunctive relief (cease and desist orders) and cannot give rise to follow-on private treble damages actions?  On the other hand, Commissioner Ohlhausen’s safe harbor seems pretty unreliable—after-the-fact balancing of competitive effects is always tricky—and there are reasons to worry about follow-on private litigation and the chilling effect it may create.  (For example, as Commissioner Kovacic observed in his N-Data dissent, many states have “little FTC Acts,” a number of which are privately enforceable in treble damages actions.)

At this point, I’m inclined to side with Commissioner Wright on the scope of the safe harbor.  There are few practices that occasion genuine harm to competition but are not covered by the Sherman and Clayton Acts, and most of those—e.g., attempts to collude, market power-creating naked acts of exclusion by firms previously lacking market power—occasion no efficiencies and thus would not come within Commissioner Wright’s broader safe harbor.  See Wright’s Examples 2, 3, 4, 5, 7, 8.  I can think of only one obvious category of conduct that (1) harms competition, (2) is not covered by the Sherman or Clayton Act, and (3) would fall within Commissioner Wright’s, but not Commissioner Ohlhausen’s, safe harbor: oligopolistic coordination using facilitating devices that were adopted unilaterally.  Several prominent antitrust scholars have argued that such conduct should be illegal, see, e.g., Richard A. Posner, Oligopoly and the Antitrust Laws: A Suggested Approach, 21 Stan. L. Rev. 1562 (1969); Herbert Hovenkamp, The Antitrust Enterprise 32-35, 128-34 (2005), and Professor Hovenkamp has argued that it should be policed under the FTC’s UMC authority.  See Herbert Hovenkamp, The Federal Trade Commission and the Sherman Act, 62 Fla. L. Rev. 871, 879-82 (2010).  In light of the judicial hostility toward that approach as evidenced in cases such as Ethyl and Boise Cascade, however, I would not be inclined to exchange Commissioner Wright’s broader safe harbor for Commissioner Ohlhausen’s narrower one in the hopes of pursuing such facilitating devices.

Of course, I may be overlooking other categories of anticompetitive conduct that are not covered by the Sherman and Clayton Acts and would be condemned under Commissioner Ohlhausen’s, but not Commissioner Wright’s, approach.  If anyone can think of something obvious, please let me know.

Regardless of how we resolve the controversy over the scope of any “efficiencies safe harbor,” Commissioners Wright and Ohlhausen deserve our thanks and admiration for pressing a long overdue issue and working to improve the state of American competition law.  I look forward to hearing others’ thoughts on the commissioners’ proposals.

Joe Sims is a Partner at Jones Day

I find that discussions on antitrust policy, if they are not to devolve into simple recitations of preferred industrial policy, are most focused when grounded in first principles and, frequently, a little history.  So a few words on both with respect to Section 5, starting with the history.

The FTC Act, in addition to being an early manifestation of the “can we help” school of antitrust, was a reaction to the perceptions of some that the Sherman Act, two decades old at the time, had not been enforced aggressively enough.  Indeed, there was considerable concern that the Supreme Court’s invention, just a couple of years earlier in the Standard Oil decision, of a Rule of Reason doctrine in interpreting the otherwise very broad words of the Sherman Act was going to effectively gut the statute.  Of course, that interpretation almost certainly saved the Sherman Act from an early demise, and opened the door for the extremely wide-ranging enforcement regime we have today.  So in large part, the premises underlying the FTC Act (including the now quaint notion that FTC Commissioners would be business experts) have proven completely wrong.  Does anyone really want to argue today that Standard Oil’s creation of a broad but limiting principle for the unworkable literal language of the Sherman Act was a bad idea?

The main point to take from this history is that the world has changed just a little bit in the last 100 years, so whatever Congress may have intended (of course, the notion of Congressional intent is itself almost a complete oxymoron) in 1914 tells us virtually nothing about what is sensible today.  So I hope we do not hear today the silly argument that the authority exists, so therefore we must use it, or the even sillier argument that if the FTC does not use this “unique” authority, it might as well go out of business.  Whether we need two antitrust agencies is a very valid question, but as we have seen for the last hundred years, Section 5 has very little to add to that debate.

So the real issue today is not what Congress intended a century ago, but what is sensible today – in a very different world.  And to intelligently answer that, we need to return to first principles of competition policy.  Here is how I would phrase the question:  Is even intelligent application (a heroic assumption, no doubt, but appropriate for a policy debate) of an unbounded statutory power by whoever happens to be the majority of FTC Commissioners at any given time likely to improve the competitive environment in the US?

It is very difficult for me to see how that is possible, and even harder to see how it is likely.  We know what the downside is.  Remember Mike Pertschuck saying that Section 5 could possibly be used to enforce compliance with desirable energy policies or environmental requirements, or to attack actions that, in the opinion of the FTC majority, impeded desirable employment programs or were inconsistent with the nation’s “democratic, political and social ideals.”  The two speeches he delivered on this subject in 1977 were the beginning of the end for increased Section 5 enforcement in that era, since virtually everyone who heard or read them said:  “Whoa!  Is this really what we want the FTC to be doing?”

Oh, but you say:  this is unfair, since that was then and this is now.  No FTC Chair or Commissioner would take this position today.  Well, I refer you to Jon Leibowitz’s concurring opinion in Rambus, where he says that Section 5 is “a flexible and powerful Congressional mandate to protect competition from unreasonable restraints, whether long-since recognized or newly discovered, that violate the antitrust laws, constitute incipient violations of those laws, or contravene those laws’ fundamental policies.”  Of course, unlike Mike Pertschuck, he does recognize that there must be some constraints, so his version of Section 5 would “only” reach actions that are “collusive, coercive, predatory, restrictive or deceitful, or otherwise oppressive, and without a justification grounded in legitimate, independent self-interest.”  Does that make you feel better?

Let’s be honest.  Enforcement of Section 5, if it actually becomes a regular part of the FTC toolbox, will depend solely on the common sense, good faith, and modesty of the FTC Commissioners as a group.  For purposes of this discussion, we can even assume the former two traits, although history tells us that they are not universal in this sample, because modesty will surely be the toughest test to meet.  By and large, people become FTC Commissioners to do things, not to be modest.  The Rambus dissent quotes, apparently approvingly, a statement from one Senator at the time of the FTC Act debate that “five good men [a reflection of the times] could hardly make mistakes about whether a particular practice is contrary to good morals or not.”  Really?  Don’t we have irrefutable evidence over the years that this assumption about government is clearly wrong?  But even if you don’t agree with that perception, aren’t we well past the time that we are willing to let five men or women enforce their personal moral or social or even business views with the force of law?  As Leibowitz’s outline of “reasonable” criteria shows – and as in fact the Commission’s history clearly demonstrates — if Section 5 is in the toolbox, it will be impossible to resist stretching the language to meet the perceived ill of the day, especially if and when it is too hard – meaning not enough factual or economic evidence – to carry the burden of a Sherman Act challenge.  And who knows what tomorrow’s reverse payment issue will be?

So there is a lot of downside to increased utilization of Section 5.  What is the argument on the other side of the scale?  Is there any need  — literally, any need at all — for Section 5 enforcement today?  If we did not have this anachronistic vestige of the past already on the books, would there be a groundswell of support to pass a new law giving the FTC this authority?  Is there anyone participating in this symposium that is willing to argue that there is any chance that a statue as unhinged as this to any statement of need or standard of application could become law today?  (Dodd-Frank and Obamacare are not good answers, even if they meet this prescription; the policy support in this area is not anywhere near the level of financial manipulation or health care.)

I have yet to hear anyone answer this question persuasively.  To me, it is instructive that the best illustration – certainly the most common example — anyone can give for an actual “need” for Section 5 is to attack invitations to collude – which, in case anyone has not noticed, involves conduct that by definition has no effect on anyone.  So the best argument is that we need to accept all the risks of Section 5 enforcement in order to be able to attack potential anticompetitive agreements that never actually happened?  Would we prefer that people not seek to collude?  Sure.  Does it really matter to anyone if they try and fail?  No.  And this is the best argument anyone can think of after 100 years of trying?  It does not pass the laugh test.

Section 5 is like your appendix – harmless enough if ignored and unused, but very dangerous if aroused or active.  We have already exceeded the optimal number of Section 5 cases this century, and we are only in the 14th year.  Time to stop for at least the next eight decades.  Let’s renew the debate in 2100.

Regulating the Regulators: Guidance for the FTC’s Section 5 Unfair Methods of Competition Authority

August 1, 2013

Truthonthemarket.com

Welcome!

We’re delighted to kick off our one-day blog symposium on the FTC’s unfair methods of competition (UMC) authority under Section 5 of the FTC Act.

Last month, FTC Commissioner Josh Wright began a much-needed conversation on the FTC’s UMC authority by issuing a proposed policy statement attempting to provide some meaningful guidance and limits to the FTC’s authority. Meanwhile, last week Commissioner Maureen Ohlhausen offered her own take on the issue, echoing many of Josh’s points and further extending the conversation. Considerable commentary—and even congressional attention—has been directed to the absence of UMC authority limits, the proper scope of that authority, and its significance for the businesses regulated by the Commission.

Section 5 of the FTC Act permits the agency to take enforcement actions against companies that use “unfair or deceptive acts or practices” or that employ “unfair methods of competition.” The Act doesn’t specify what these terms mean, instead leaving that determination to the FTC itself.  In the 1980s, under intense pressure from Congress, the Commission established limiting principles for its unfairness and deception authorities. But today, coming up on 100 years since the creation of the FTC, the agency still hasn’t defined the scope of its UMC authority, instead pursuing enforcement actions without any significant judicial, congressional or even self-imposed limits. And in recent years the Commission has seemingly expanded its interpretation of its UMC authority, bringing a string of standalone Section 5 cases (including against Intel, Rambus, N-Data, Google and others), alleging traditional antitrust injury but avoiding the difficulties of pursuing such actions under the Sherman Act (or, in a few cases, bringing separate claims under both Section 5 and Section 2).

We hope this symposium will provide important insights and stand as a useful resource for the ongoing discussion.

We’ve lined up an outstanding and diverse group of scholars and practitioners to participate in the symposium.  They include:

  • David Balto, Law Offices of David Balto [1] [2]
  • Terry Calvani, Freshfields [1]
  • James Cooper, GMU Law & Economics Center [1] [2]
  • Dan Crane, Michigan Law [1]
  • Paul Denis, Dechert [1]
  • Angela Diveley, Freshfields [1]
  • Gus Hurwitz, Nebraska Law [1] [2]
  • Thom Lambert, Missouri Law [1]
  • Marina Lao, Seton Hall Law [1]
  • Tad Lipsky, Latham & Watkins [1]
  • Geoffrey Manne, Lewis & Clark Law/ICLE [1]
  • Joe Sims, Jones Day [1]
  • Josh Wright, FTC [1]
  • Tim Wu, Columbia Law [1]

The first of the participants’ initial posts will appear momentarily, with additional posts appearing throughout the day. We hope to generate a lively discussion, and expect some of the participants to offer follow up posts as well as comments on their fellow participants’ posts—please be sure to check back throughout the day and be sure to check the comments. We hope our readers will join us in the comments, as well.

Once again, welcome!

Co-authored with Berin Szoka

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

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

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

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

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

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

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

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

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

And as Wright’s Statement notes,

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

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

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

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

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

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

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

The Status Quo

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

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

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

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

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

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

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

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

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

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

Requirement #1: Harm to Competition

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

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

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

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

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

The Commission shall have no authority under this section or section 57a of this title to declare unlawful an act or practice on the grounds that such act or practice is unfair unless the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition.

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

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

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

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

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

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

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

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

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

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

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

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

Requirement #2: Absence of Cognizable Efficiencies

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

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

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

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

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

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

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

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

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

Fundamentally, as Commissioner Wright explained in his speech,

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

joshua-wright As Thom noted (here and here), Josh’s speech at the ABA Spring Meeting was fantastic.  In laying out his agenda at the FTC, Josh highlighted two areas on which he intends to focus: Section 5 and public restraints on trade.  These are important, even essential, areas, and Josh’s leadership here will be most welcome.

I’m especially encouraged by his comments on Section 5.  As readers of this blog know, Section 5 has been an issue near and dear to our hearts, and Josh’s intention to make it a centerpiece of his agenda at the Commission should come as no surprise. (There are too many posts on topic to link them individually here, but this link includes all our posts tagged with Section 5.  My own most recent discussion of the general topic (with Berin Szoka) is here).

Of perhaps greatest significance is this bit from Josh’s speech:

The Commission, however, has another choice available. It can and should issue a policy statement clearly setting forth its views on what constitutes an unfair method of competition as we have done with respect to our consumer protection mission…. I firmly believe this Commission is up to this important task and I look forward to working with my fellow Commissioners. In that spirit, I will soon informally and publicly distribute a proposed Section 5 Unfair Methods Policy Statement more fully articulating my views and perhaps even providing a useful starting point for a fruitful discussion among the enforcement agencies, the antitrust bar, consumer groups, and the business community.

This is great news, and I eagerly look forward to Josh’s proposed Policy Statement.  As Berin and I noted (and as others, including most notably Bill Kovacic, have noted, as well), this kind of guidance is sorely lacking and much needed:

Rather than attempting to do this in the course of a single litigation, the agency ought to heed Kovacic and Winerman’s advice and do more to “inform judicial thinking” such as by “issu[ing] guidelines or policy statements that spell out its own view about the appropriate analytical framework.”

Not surprisingly, my views line up with Josh’s, and his speech is full of important comments on the current state of Section 5 enforcement at the Commission. Of note:

(1) Objective evaluation of the historical record reveals a remarkable and unfortunate gap between the theoretical promise of Section 5 as articulated by Congress and its application in practice by the Commission;

(2) There is little hope for Section 5 to play a productive role in antitrust enforcement unless the Commission articulates in a policy statement about precisely what constitutes an unfair method, how the agency will decide whether to bring unfair method claims, and a general framework including guiding and limiting principles for evaluating Section 5 cases.

* * *

What does a frank assessment of the 100 year record of Section 5 tell us about its contribution to the competition mission? Or as I might put it, has Section 5 lived up to its promise of nudging the FTC toward evidence-based antitrust? I believe the answer to that question is a resounding “no.” There is no shortage of scholars and commentators filling the empty vessel of Section 5 with visions or further promise or purpose of, for example, creating convergence among international jurisdictions, shifting the attention of competition policy from economic welfare to consumer choice, or incorporating behavioral economics into modern antitrust. History, however, tells us that Section 5 has fallen far short of its intended promise. Section 5 has not produced more than a handful of adjudicated decisions with any durable impact on antitrust doctrine or economic welfare.

* * *

After one hundred years the balance of evidence more than suggests the Commission’s use of Section 5 has done little to influence antitrust doctrine and less to inform judicial thinking or to provide guidance to the business community. This void is not a small matter for an administrative agency whose institutional blueprint contemplated such a significant role for Section 5. In my view, it is the Commission’s duty to provide that guidance. But beyond our obligation as responsible stewards of the FTC and consumers through execution of our competition mission, there is considerable risk to the agency of continuing on its current path of putting Section 5 to use without providing guidance. I simply do not believe that path is sustainable or sound competition policy. Section 5 will not live up to its promise of offering an analytically coherent contribution to competition policy if the Commission continues not to offer guidance.

Focusing in particular on the problem of the currently unfettered Section 5 and how it might sensibly be circumscribed, Josh makes some great points:

First, Section 5 should not be used to evade existing antitrust law. Where courts have proven competent to evaluate a particular type of business conduct under the traditional antitrust laws, there is little reason for the Commission to step in under its unfair methods authority. This is especially the case when Section 5 is used to take advantage of a weakened requirement to prove consumer harm in the rigorous manner required in, for example, Section 2 cases. Evading the consumer welfare proof requirements of existing Sherman Act jurisprudence reduces the credibility of the agency, runs the risk that procompetitive conduct will be condemned under Section 5, and circumvents the healthy development of Sherman Act jurisprudence in the courts.

* * *

A second potential limiting principle is a restriction that Section 5 unfair methods cases – as is the case with invitation to collude cases – do not involve plausible efficiency claims. Not only does the lack of efficiency justification reduce any potential collateral consequences associated with false positives, but determining the presence of absence of cognizable efficiencies also plays to a core institutional strength of the Commission. The Commission’s learning and expertise in this regard has already influenced the evolution of the Merger Guidelines, and is applied on a regular basis.

I have no doubt Josh can and will deliver on his promise of working with the other Commissioners to bring some much needed sense to this problematic aspect of the FTC’s authority. This is an enormously important issue, one in great need of attention, and I can think of no one better than Josh to lead the effort to address it.

The Federal Trade Commission yesterday closed its investigation of Google’s search business (see my comment here) without taking action. The FTC did, however, enter into a settlement with Google over the licensing of Motorola Mobility’s standards-essential patents (SEPs). The FTC intends that agreement to impose some limits on an area of great complexity and vigorous debate among industry, patent experts and global standards bodies: The allowable process for enforcing FRAND (fair, reasonable and non-discriminatory) licensing of SEPs, particularly the use of injunctions by patent holders to do so. According to Chairman Leibowitz, “[t]oday’s landmark enforcement action will set a template for resolution of SEP licensing disputes across many industries.” That effort may or may not be successful. It also may be misguided.

In general, a FRAND commitment incentivizes innovation by allowing a SEP owner to recoup its investments and the value of its technology through licensing, while, at the same, promoting competition and avoiding patent holdup by ensuring that licensing agreements are reasonable. When the process works, and patent holders negotiate licensing rights in good faith, patents are licensed, industries advance and consumers benefit.

FRAND terms are inherently indeterminate and flexible—indeed, they often apply precisely in situations where licensors and licensees need flexibility because each licensing circumstance is nuanced and a one-size-fits-all approach isn’t workable. Superimposing process restraints from above isn’t necessarily the best thing in dealing with what amounts to a contract dispute. But few can doubt the benefits of greater clarity in this process; the question is whether the FTC’s particular approach to the problem sacrifices too much in exchange for such clarity.

The crux of the issue in the Google consent decree—and the most controversial aspect of SEP licensing negotiations—is the role of injunctions. The consent decree requires that, before Google sues to enjoin a manufacturer from using its SEPs without a license, the company must follow a prescribed path in licensing negotiations. In particular:

Under this Order, before seeking an injunction on FRAND-encumbered SEPs, Google must: (1) provide a potential licensee with a written offer containing all of the material license terms necessary to license its SEPs, and (2) provide a potential licensee with an offer of binding arbitration to determine the terms of a license that are not agreed upon. Furthermore, if a potential licensee seeks judicial relief for a FRAND determination, Google must not seek an injunction during the pendency of the proceeding, including appeals.

There are a few exceptions, summarized by Commissioner Ohlhausen:

These limitations include when the potential licensee (a) is outside the jurisdiction of the United States; (b) has stated in writing or sworn testimony that it will not license the SEP on any terms [in other words, is not a “willing licensee”]; (c) refuses to enter a license agreement on terms set in a final ruling of a court – which includes any appeals – or binding arbitration; or (d) fails to provide written confirmation to a SEP owner after receipt of a terms letter in the form specified by the Commission. They also include certain instances when a potential licensee has brought its own action seeking injunctive relief on its FRAND-encumbered SEPs.

To the extent that the settlement reinforces what Google (and other licensors) would do anyway, and even to the extent that it imposes nothing more than an obligation to inject a neutral third party into FRAND negotiations to assist the parties in resolving rate disputes, there is little to complain about. Indeed, this is the core of the agreement, and, importantly, it seems to preserve Google’s right to seek injunctions to enforce its patents, subject to the agreement’s process requirements.

Industry participants and standard-setting organizations have supported injunctions, and the seeking and obtaining of injunctions against infringers is not in conflict with SEP patentees’ obligations. Even the FTC, in its public comments, has stated that patent owners should be able to obtain injunctions on SEPs when an infringer has rejected a reasonable license offer. Thus, the long-anticipated announcement by the FTC in the Google case may help to provide some clarity to the future negotiation of SEP licenses, the possible use of binding arbitration, and the conditions under which seeking injunctive relief will be permissible (as an antitrust matter).

Nevertheless, U.S. regulators, including the FTC, have sometimes opined that seeking injunctions on products that infringe SEPs is not in the spirit of FRAND. Everyone seems to agree that more certainty is preferable; the real issue is whether and when injunctions further that aim or not (and whether and when they are anticompetitive).

In October, Renata Hesse, then Acting Assistant Attorney General for the Department of Justice’s Antitrust Division, remarked during a patent roundtable that

[I]t would seem appropriate to limit a patent holder’s right to seek an injunction to situations where the standards implementer is unwilling to have a neutral third-party determine the appropriate F/RAND terms or is unwilling to accept the F/RAND terms approved by such a third-party.

In its own 2011 Report on the “IP Marketplace,” the FTC acknowledged the fluidity and ambiguity surrounding the meaning of “reasonable” licensing terms and the problems of patent enforcement. While noting that injunctions may confer a costly “hold-up” power on licensors that wield them, the FTC nevertheless acknowledged the important role of injunctions in preserving the value of patents and in encouraging efficient private negotiation:

Three characteristics of injunctions that affect innovation support generally granting an injunction. The first and most fundamental is an injunction’s ability to preserve the exclusivity that provides the foundation of the patent system’s incentives to innovate. Second, the credible threat of an injunction deters infringement in the first place. This results from the serious consequences of an injunction for an infringer, including the loss of sunk investment. Third, a predictable injunction threat will promote licensing by the parties. Private contracting is generally preferable to a compulsory licensing regime because the parties will have better information about the appropriate terms of a license than would a court, and more flexibility in fashioning efficient agreements.

* * *

But denying an injunction every time an infringer’s switching costs exceed the economic value of the invention would dramatically undermine the ability of a patent to deter infringement and encourage innovation. For this reason, courts should grant injunctions in the majority of cases.…

Consistent with this view, the European Commission’s Deputy Director-General for Antitrust, Cecilio Madero Villarejo, recently expressed concern that some technology companies that complain of being denied a license on FRAND terms never truly intend to acquire licenses, but rather “want[] to create conditions for a competition case to be brought.”

But with the Google case, the Commission appears to back away from its seeming support for injunctions, claiming that:

Seeking and threatening injunctions against willing licensees of FRAND-encumbered SEPs undermines the integrity and efficiency of the standard-setting process and decreases the incentives to participate in the process and implement published standards. Such conduct reduces the value of standard setting, as firms will be less likely to rely on the standard-setting process.

Reconciling the FTC’s seemingly disparate views turns on the question of what a “willing licensee” is. And while the Google settlement itself may not magnify the problems surrounding the definition of that term, it doesn’t provide any additional clarity, either.

The problem is that, even in its 2011 Report, in which FTC noted the importance of injunctions, it defines a willing licensee as one who would license at a hypothetical, ex ante rate absent the threat of an injunction and with a different risk profile than an after-the-fact infringer. In other words, the FTC’s definition of willing licensee assumes a willingness to license only at a rate determined when an injunction is not available, and under the unrealistic assumption that the true value of a SEP can be known ex ante. Not surprisingly, then, the Commission finds it easy to declare an injunction invalid when a patentee demands a (higher) royalty rate in an actual negotiation, with actual knowledge of a patent’s value and under threat of an injunction.

As Richard Epstein, Scott Kieff and Dan Spulber discuss in critiquing the FTC’s 2011 Report:

In short, there is no economic basis to equate a manufacturer that is willing to commit to license terms before the adoption and launch of a standard, with one that instead expropriates patent rights at a later time through infringement. The two bear different risks and the late infringer should not pay the same low royalty as a party that sat down at the bargaining table and may actually have contributed to the value of the patent through its early activities. There is no economically meaningful sense in which any royalty set higher than that which a “willing licensee would have paid” at the pre-standardization moment somehow “overcompensates patentees by awarding more than the economic value of the patent.”

* * *

Even with a RAND commitment, the patent owner retains the valuable right to exclude (not merely receive later compensation from) manufacturers who are unwilling to accept reasonable license terms. Indeed, the right to exclude influences how those terms should be calculated, because it is quite likely that prior licensees in at least some areas will pay less if larger numbers of parties are allowed to use the same technology. Those interactive effects are ignored in the FTC calculations.

With this circular logic, all efforts by patentees to negotiate royalty rates after infringement has occurred can be effectively rendered anticompetitive if the patentee uses an injunction or the threat of an injunction against the infringer to secure its reasonable royalty.

The idea behind FRAND is rather simple (reward inventors; protect competition), but the practice of SEP licensing is much more complicated. Circumstances differ from case to case, and, more importantly, so do the parties’ views on what may constitute an appropriate licensing rate under FRAND. As I have written elsewhere, a single company may have very different views on the meaning of FRAND depending on whether it is the licensor or licensee in a given negotiation—and depending on whether it has already implemented a standard or not. As one court looking at the very SEPs at issue in the Google case has pointed out:

[T]he court is mindful that at the time of an initial offer, it is difficult for the offeror to know what would in fact constitute RAND terms for the offeree. Thus, what may appear to be RAND terms from the offeror’s perspective may be rejected out-of-pocket as non-RAND terms by the offeree. Indeed, it would appear that at any point in the negotiation process, the parties may have a genuine disagreement as to what terms and conditions of a license constitute RAND under the parties’ unique circumstances.

The fact that many firms engaged in SEP negotiations are simultaneously and repeatedly both licensors and licensees of patents governed by multiple SSOs further complicates the process—but also helps to ensure that it will reach a conclusion that promotes innovation and ensures that consumers reap the rewards.

In fact, an important issue in assessing the propriety of injunctions is the recognition that, in most cases, firms would rather license their patents and receive royalties than exclude access to their IP and receive no compensation (and incur the costs of protracted litigation, to boot). Importantly, for firms that both license out their own patents and license in those held by other firms (the majority of IT firms and certainly the norm for firms participating in SSOs), continued interactions on both sides of such deals help to ensure that licensing—not withholding—is the norm.

Companies are waging the smartphone patent wars with very different track records on SSO participation. Apple, for example, is relatively new to the mobile communications space and has relatively few SEPs, while other firms, like Samsung, are long-time players in the space with histories of extensive licensing (in both directions). But, current posturing aside, both firms have an incentive to license their patents, as Mark Summerfield notes:

Apple’s best course of action will most likely be to enter into licensing agreements with its competitors, which will not only result in significant revenues, but also push up the prices (or reduce the margins) on competitive products.

While some commentators make it sound as if injunctions threaten to cripple smartphone makers by preventing them from licensing essential technology on viable terms, companies in this space have been perfectly capable of orchestrating large-scale patent licensing campaigns. That these may increase costs to competitors is a feature—not a bug—of the system, representing the return on innovation that patents are intended to secure. Microsoft has wielded its sizeable patent portfolio to drive up the licensing fees paid by Android device manufacturers, and some commentators have even speculated that Microsoft makes more revenue from Android than Google does. But while Microsoft might prefer to kill Android with its patents, given the unlikeliness of this, as MG Siegler notes,

[T]he next best option is to catch a free ride on the Android train. Patent licensing deals already in place with HTC, General Dynamics, and others could mean revenues of over $1 billion by next year, as Forbes reports. And if they’re able to convince Samsung to sign one as well (which could effectively force every Android partner to sign one), we could be talking multiple billions of dollars of revenue each year.

Hand-wringing about patents is the norm, but so is licensing, and your smartphone exists, despite the thousands of patents that read on it, because the firms that hold those patents—some SEPs and some not—have, in fact, agreed to license them.

The inability to seek an injunction against an infringer, however, would ensure instead that patentees operate with reduced incentives to invest in technology and to enter into standards because they are precluded from benefiting from any subsequent increase in the value of their patents once they do so. As Epstein, Kieff and Spulber write:

The simple reality is that before a standard is set, it just is not clear whether a patent might become more or less valuable. Some upward pressure on value may be created later to the extent that the patent is important to a standard that is important to the market. In addition, some downward pressure may be caused by a later RAND commitment or some other factor, such as repeat play. The FTC seems to want to give manufacturers all of the benefits of both of these dynamic effects by in effect giving the manufacturer the free option of picking different focal points for elements of the damages calculations. The patentee is forced to surrender all of the benefit of the upward pressure while the manufacturer is allowed to get all of the benefit of the downward pressure.

Thus the problem with even the limited constraints imposed by the Google settlement: To the extent that the FTC’s settlement amounts to a prohibition on Google seeking injunctions against infringers unless the company accepts the infringer’s definition of “reasonable,” the settlement will harm the industry. It will reinforce a precedent that will likely reduce the incentives for companies and individuals to innovate, to participate in SSOs, and to negotiate in good faith.

Contrary to most assumptions about the patent system, it needs stronger, not weaker, property rules. With a no-injunction rule (whether explicit or de facto (as the Google settlement’s definition of “willing licensee” unfolds)), a potential licensee has little incentive to negotiate with a patent holder and can instead refuse to license, infringe, try its hand in court, avoid royalties entirely until litigation is finished (and sometimes even longer), and, in the end, never be forced to pay a higher royalty than it would have if it had negotiated before the true value of the patents was known.

Flooding the courts and discouraging innovation and peaceful negotiations hardly seem like benefits to the patent system or the market. Unfortunately, the FTC’s approach to SEP licensing exemplified by the Google settlement may do just that. Continue Reading…

Co-authored with Berin Szoka

In the past two weeks, Members of Congress from both parties have penned scathing letters to the FTC warning of the consequences (both to consumers and the agency itself) if the Commission sues Google not under traditional antitrust law, but instead by alleging unfair competition under Section 5 of the FTC Act. The FTC is rumored to be considering such a suit, and FTC Chairman Jon Leibowitz and Republican Commissioner Tom Rosch have expressed a desire to litigate such a so-called “pure” Section 5 antitrust case — one not adjoining a cause of action under the Sherman Act. Unfortunately for the Commissioners, no appellate court has upheld such an action since the 1960s.

This brewing standoff is reminiscent of a similar contest between Congress and the FTC over the Commission’s aggressive use of Section 5 in consumer protection cases in the 1970s. As Howard Beales recounts, the FTC took an expansive view of its authority and failed to produce guidelines or limiting principles to guide its growing enforcement against “unfair” practices — just as today it offers no limiting principles or guidelines for antitrust enforcement under the Act. Only under heavy pressure from Congress, including a brief shutdown of the agency (and significant public criticism for becoming the “National Nanny“), did the agency finally produce a Policy Statement on Unfairness — which Congress eventually codified by statute.

Given the attention being paid to the FTC’s antitrust authority under Section 5, we thought it would be helpful to offer a brief primer on the topic, highlighting why we share the skepticism expressed by the letter-writing members of Congress (along with many other critics).

The topic has come up, of course, in the context of the FTC’s case against Google. The scuttlebut is that the Commission believes it may not be able to bring and win a traditional, Section 2 antitrust action, and so may resort to Section 5 to make its case — or simply force a settlement, as the FTC did against Intel in late 2010. While it may be Google’s head on the block today, it could be anyone’s tomorrow. This isn’t remotely just about Google; it’s about broader concerns over the Commission’s use of Section 5 to prosecute monopolization cases without being subject to the rigorous economic standards of traditional antitrust law.

Background on Section 5

Section 5 has two “prongs.” The first, reflected in its prohibition of “unfair acts or deceptive acts or practices” (UDAP) is meant (and has previously been used—until recently, as explained) as a consumer protection statute. The other, prohibiting “unfair methods of competition” (UMC) has, indeed, been interpreted to have relevance to competition cases.

Most commonly (and commonly-accepted), the UMC language has been viewed to authorize the agency to bring cases that fill the gaps between clearly anticompetitive conduct and the language of the Sherman Act. Principally, this has been invoked in “invitation to collude” cases, which raise the spectre of price-fixing but nevertheless do not meet the literal prohibition against “agreement in restraint of trade” under Section 1 of the Sherman Act.

Over strenuous objections from dissenting Commissioners (and only in consent decrees; not before courts), the FTC has more recently sought to expand the reach of the UDAP language beyond the consumer protection realm to address antitrust concerns that would likely be non-starters under the Sherman Act.

In N-Data, the Commission brought and settled a case invoking both the UDAP and UMC prongs of Section 5 to reach (alleged) conduct that amounted to breach of a licensing agreement without the requisite (Sherman Act) Section 2 claim of exclusionary conduct (which would have required that the FTC show that N-Data’s conducted had the effect of excluding its rivals without efficiency or welfare-enhancing properties). Although the FTC’s claims fall outside the ambit of Section 2, the Commission’s invocation of Section 5’s UDAP language was so broad that it could — quite improperly — be employed to encompass traditional Section 2 claims nonetheless, but without the rigor Section 2 requires (as the vigorous dissents by Commissioners Kovacic and Majoras discuss). As Commissioner Kovacic wrote in his dissent:

[T]he framework that the [FTC’s] Analysis presents for analyzing the challenged conduct as an unfair act or practice would appear to encompass all behavior that could be called a UMC or a violation of the Sherman or Clayton Acts. The Commission’s discussion of the UAP [sic] liability standard accepts the view that all business enterprises – including large companies – fall within the class of consumers whose injury is a worthy subject of unfairness scrutiny. If UAP coverage extends to the full range of business-to-business transactions, it would seem that the three-factor test prescribed for UAP analysis would capture all actionable conduct within the UMC prohibition and the proscriptions of the Sherman and Clayton Acts. Well-conceived antitrust cases (or UMC cases) typically address instances of substantial actual or likely harm to consumers. The FTC ordinarily would not prosecute behavior whose adverse effects could readily be avoided by the potential victims – either business entities or natural persons. And the balancing of harm against legitimate business justifications would encompass the assessment of procompetitive rationales that is a core element of a rule of reason analysis in cases arising under competition law.

In Intel, the most notorious of the recent FTC Section 5 antitrust actions, the Commission brought (and settled) a straightforward (if unwinnable) Section 2 case as a Section 5 case (with Section 2 “tag along” claims), using the justification that it simply couldn’t win a Section 2 case under current jurisprudence. Intel presumably settled the case because the absence of judicial limits under Section 5 made its outcome far less certain — and presumably the FTC brought the case under Section 5 for the same reason.

In Intel, there was no effort to distinguish Section 5 grounds from those under Section 2. Rather, the FTC claimed that the limiting jurisprudence under Section 2 wasn’t meant to rein in agencies, but merely private plaintiffs. This claim falls flat, as one of us (Geoff) has noted:

[Chairman] Leibowitz’ continued claim that courts have reined in Sherman Act jurisprudence only out of concern with the incentives and procedures of private enforcement, and not out of a concern with a more substantive balancing of error costs—errors from which the FTC is not, unfortunately immune—seems ridiculous to me. To be sure (as I said before), the procedural background matters as do the incentives to bring cases that may prove to be inefficient.

But take, for example, Twombly, mentioned by Leibowitz as one of the cases that has recently reined in Sherman Act enforcement in order to constrain overzealous private enforcement (and thus not in a way that should apply to government enforcement). . . .

But the over-zealousness of private plaintiffs is not all [Twombly] was about, as the Court made clear:

The inadequacy of showing parallel conduct or interdependence, without more, mirrors the ambiguity of the behavior: consistent with conspiracy, but just as much in line with a wide swath of rational and competitive business strategy unilaterally prompted by common perceptions of the market. Accordingly, we have previously hedged against false inferences from identical behavior at a number of points in the trial sequence.

Hence, when allegations of parallel conduct are set out in order to make a §1 claim, they must be placed in a context that raises a suggestion of a preceding agreement, not merely parallel conduct that could just as well be independent action. [Citations omitted].

The Court was appropriately concerned with the ability of decision-makers to separate pro-competitive from anticompetitive conduct. Even when the FTC brings cases, it and the court deciding the case must make these determinations. And, while the FTC may bring fewer strike suits, it isn’t limited to challenging conduct that is simple to identify as anticompetitive. Quite the opposite, in fact—the government has incentives to develop and bring suits proposing novel theories of anticompetitive conduct and of enforcement (as it is doing in the Intel case, for example).

Problems with Unleashing Section 5

It would be a serious problem — as the Members of Congress who’ve written letters seem to realize — if Section 5 were used to sidestep the important jurisprudential limitations on Section 2 by focusing on such unsupported theories as “reduction in consumer choice” instead of Section 2’s well-established consumer welfare standard. As Geoff has noted:

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

* * *

One of the most important shifts in antitrust over the past 30 years has been the move away from indirect and unreliable proxies of consumer harm toward a more direct, effects-based analysis. Like the now archaic focus on market concentration in the structure-conduct-performance framework at the core of “old” merger analysis, the consumer choice framework [proposed by Commissioner Rosch as a cause of action under Section 5] substitutes an indirect and deeply flawed proxy for consumer welfare for assessment of economically relevant economic effects. By focusing on the number of choices, the analysis shifts attention to the wrong question.

The fundamental question from an antitrust perspective is whether consumer choice is a better predictor of consumer outcomes than current tools allow. There doesn’t appear to be anything in economic theory to suggest that it would be. Instead, it reduces competitive analysis to a single attribute of market structure and appears susceptible to interpretations that would sacrifice a meaningful measure of consumer welfare (incorporating assessment of price, quality, variety, innovation and other amenities) on economically unsound grounds. It is also not the law.

Commissioner Kovacic echoed this in his dissent in N-Data:

More generally, it seems that the Commission’s view of unfairness would permit the FTC in the future to plead all of what would have been seen as competition-related infringements as constituting unfair acts or practices.

And the same concerns animate Kovacic’s belief (drawn from an article written with then-Attorney Advisor Mark Winerman) that courts will continue to look with disapproval on efforts by the FTC to expand its powers:

We believe that UMC should be a competition-based concept, in the modern sense of fostering improvements in economic performance rather than equating the health of the competitive process with the wellbeing of individual competitors, per se. It should not, moreover, rely on the assertion in [the Supreme Court’s 1972 Sperry & Hutchinson Trading Stamp case] that the Commission could use its UMC authority to reach practices outside both the letter and spirit of the antitrust laws. We think the early history is now problematic, and we view the relevant language in [Sperry & Hutchinson] with skepticism.

Representatives Eshoo and Lofgren were even more direct in their letter:

Expanding the FTC’s Section 5 powers to include antitrust matters could lead to overbroad authority that amplifies uncertainty and stifles growth. . . . If the FTC intends to litigate under this interpretation of Section 5, we strongly urge the FTC to reconsider.

But it isn’t only commentators and Congressmen who point to this limitation. The FTC Act itself contains such a limitation. Section 5(n) of the Act, the provision added by Congress in 1994 to codify the core principles of the FTC’s 1980 Unfairness Policy Statement, says that:

The Commission shall have no authority under this section or section 57a of this title to declare unlawful an act or practice on the grounds that such act or practice is unfair unless the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition. [Emphasis added].

In other words, Congress has already said, quite clearly, that Section 5 isn’t a blank check. Yet Chairman Leibowitz seems to be banking on the dearth of direct judicial precedent saying so to turn it into one — as do those who would cheer on a Section 5 antitrust case (against Google, Intel or anyone else). Given the unique breadth of the FTC’s jurisdiction over the entire economy, the agency would again threaten to become a second national legislature, capable of regulating nearly the entire economy.

The Commission has tried — and failed — to bring such cases before the courts in recent years. But the judiciary has not been receptive to an invigoration of Section 5 for several reasons. Chief among these is that the agency simply hasn’t defined the scope of its power over unfair competition under the Act, and the courts hesitate to let the Commission set the limits of its own authority. As Kovacic and Winerman have noted:

The first [reason for judicial reluctance in Section 5 cases] is judicial concern about the apparent absence of limiting principles. The tendency of the courts has been to endorse limiting principles that bear a strong resemblance to standards familiar to them from Sherman Act and Clayton Act cases. The cost-benefit concepts devised in rule of reason cases supply the courts with natural default rules in the absence of something better.

The Commission has done relatively little to inform judicial thinking, as the agency has not issued guidelines or policy statements that spell out its own view about the appropriate analytical framework. This inactivity contrasts with the FTC’s efforts to use policy statements to set boundaries for the application of its consumer protection powers under Section 5.

This concern was stressed in the letter sent by Senator DeMint and other Republican Senators to Chairman Leibowitz:

[W]e are concerned about the apparent eagerness of the Commission under your leadership to expand Section 5 actions without a clear indication of authority or a limiting principle. When a federal regulatory agency uses creative theories to expand its activities, entrepreneurs may be deterred from innovating and growing lest they be targeted by government action.

As we have explained many times (see, e.g., herehere and here), a Section 2 case against Google will be an uphill battle. As far as we have seen publicly, complainants have offered only harm to competitors — not harm to consumers — to justify such a case. It is little surprise, then, that the agency (or, more accurately, Chairman Leibowitz and Commissioner Rosch) may be seeking to use the less-limited power of Section 5 to mount such a case.

In a blog post in 2011, Geoff wrote:

Commissioner Rosch has claimed that Section Five could address conduct that has the effect of “reducing consumer choice” — an effect that a very few commentators support without requiring any evidence that the conduct actually reduces consumer welfare. Troublingly, “reducing consumer choice” seems to be a euphemism for “harm to competitors, not competition,” where the reduction in choice is the reduction of choice of competitors who may be put out of business by competitive behavior.

The U.S. has a long tradition of resisting enforcement based on harm to competitors without requiring a commensurate, strong showing of harm to consumers — an economically-sensible tradition aimed squarely at minimizing the likelihood of erroneous enforcement. The FTC’s invigorated interest in Section Five contemplates just such wrong-headed enforcement, however, to the inevitable detriment of the very consumers the agency is tasked with protecting.

In fact, the theoretical case against Google depends entirely on the ways it may have harmed certain competitors rather than on any evidence of actual harm to consumers (and in the face of ample evidence of significant consumer benefits).

* * *

In each of [the complaints against Google], the problem is that the claimed harm to competitors does not demonstrably translate into harm to consumers.

For example, Google’s integration of maps into its search results unquestionably offers users an extremely helpful presentation of these results, particularly for users of mobile phones. That this integration might be harmful to MapQuest’s bottom line is not surprising — but nor is it a cause for concern if the harm flows from a strong consumer preference for Google’s improved, innovative product. The same is true of the other claims. . . .

To the extent that the FTC brings an antitrust case against Google under Section 5, using the Act to skirt the jurisprudential limitations (and associated economic rigor) that make a Section 2 case unwinnable, it would be contravening congressional intent, judicial precedent, the plain language of the FTC Act, and the collected wisdom of the antitrust commentariat that sees such an action as inappropriate. This includes not just traditional antitrust-skeptics like us, but even antitrust-enthusiasts like Allen Grunes, who has written:

The FTC, of course, has Section 5 authority. But there is well-developed case law on monopolization under Section 2 of the Sherman Act. There are no doctrinal “gaps” that need to be filled. For that reason it would be inappropriate, in my view, to use Section 5 as a crutch if the evidence is insufficient to support a case under Section 2.

As Geoff has said:

Modern antitrust analysis, both in scholarship and in the courts, quite properly rejects the reductive and unsupported sort of theories that would undergird a Section 5 case against Google. That the FTC might have a better chance of winning a Section 5 case, unmoored from the economically sound limitations of Section 2 jurisprudence, is no reason for it to pursue such a case. Quite the opposite: When consumer welfare is disregarded for the sake of the agency’s power, it ceases to further its mandate. . . . But economic substance, not self-aggrandizement by rhetoric, should guide the agency. Competition and consumers are dramatically ill-served by the latter.

Conclusion: What To Do About Unfairness?

So, what should the FTC do with Section 5? The right answer may be “nothing” (and probably is, in our opinion). But even those who think something should be done to apply the Act more broadly to allegedly anticompetitive conduct should be able to agree that the FTC ought not bring a case under Section 5’s UDAP language without first defining with analytical rigor what its limiting principles are.

Rather than attempting to do this in the course of a single litigation, the agency ought to heed Kovacic and Winerman’s advice and do more to “inform judicial thinking” such as by “issu[ing] guidelines or policy statements that spell out its own view about the appropriate analytical framework.” The best way to start that process would be for whoever succeeds Leibowitz as chairman to convene a workshop on the topic. (As one of us (Berin) has previously suggested, the FTC is long overdue on issuing guidelines to explain how it has applied its Unfairness and Deception Policy Statements in UDAP consumer protection cases. Such a workshop would dovetail nicely with this.)

The question posed should not presume that Section 5’s UDAP language ought to be used to reach conduct actionable under the antitrust statutes at all. Rather, the fundamental question to be asked is whether the use of Section 5 in antitrust cases is a relic of a bygone era before antitrust law was given analytical rigor by economics. If the FTC cannot rigorously define an interpretation of Section 5 that will actually serve consumer welfare — which the Supreme Court has defined as the proper aim of antitrust law — Congress should explicitly circumscribe it once and for all, limiting Section 5 to protecting consumers against unfair and deceptive acts and practices and, narrowly, prohibiting unfair competition in the form of invitations to collude. The FTC (along with the DOJ and the states) would still regulate competition through the existing antitrust laws. This might be the best outcome of all.

Previous commentary by us on Section 5: