NO POWER? NO PROBLEM. TOWARD A MORE REASONABLE TEST FOR COMPETITOR COLLABORATIONS

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1 NO POWER? NO PROBLEM. TOWARD A MORE REASONABLE TEST FOR COMPETITOR COLLABORATIONS Casey W. Halladay Contact Information: Casey W. Halladay, th Street NW, Apt. 402, Washington, DC, 20009, casey.halladay@gmail.com, tel (267) Word Count: 13,667 Abstract: This paper advocates a reassessment of the per se rule in Sherman Act Section 1 cases, to require proof that the parties to a challenged agreement possess market power before subjecting the parties to Section 1 s severe penalties. My call for reassessment of the per se rule presents two principal arguments: (1) that what I have termed the super per se test, rejecting proof of market power, developed in the 1940 Socony-Vacuum Oil decision needlessly broke with decades of Supreme Court precedent; and (2) that the three most common policy justifications (business efficiency, deterrence, and administrative efficiency) for the Rule have been overstated and are much-diminished in modern antitrust law. Eliminating the vagueness and associated chilling effect of the per se rule would eliminate at least past of the competitive disadvantage that U.S. firms face in the global marketplace. I. Introduction It is well-known that American antitrust law treats certain horizontal collaborations between competitors as per se illegal that is, such behavior is considered to be illegal without requiring proof of the competitors combined market power or any anticompetitive effects of their conduct. Leading antitrust scholars Philip Areeda and Herbert Hovenkamp have described the per se rule as one which condemns conduct without proof of power, effect, or purpose and without hearing claims of legitimate objectives. 1 Other forms of collaboration between rivals are analyzed according to the so-called rule of reason which B.A., M.A., LL.B., LL.M. An earlier version of this article was prepared in satisfaction of the research and writing requirement of the author s LL.M. year (2005) at the Harvard Law School. I would like to thank Professor Einer Elhauge of the Harvard Law faculty for his many helpful comments and insights as my Advisor for that paper. 1 See PHILLIP C. AREEDA & HERBERT HOVENKAMP, FUNDAMENTALS OF ANTITRUST LAW (3 rd ed. 2004).

2 Casey W. Halladay William E. Swope Antitrust Prize Submission 2 examines, inter alia, whether the parties possess market power (the ability to raise and maintain prices at supracompetitive levels or decrease output) and any resulting anti-competitive effects (e.g., increased prices, decreased output or service levels) in a market. If the parties do not possess market power, and their conduct does not have anti-competitive effects, there is no liability. Where a court finds that parties have engaged in conduct that violates Section 1, Congress has provided very serious penalties, including fines of up to $100 million and/or imprisonment for up to ten years. Customers and/or suppliers of the parties may bring private antitrust enforcement actions to recover treble damages. Given these severe consequences, the distinction as to whether conduct is per se illegal, or subject to examination under the rule of reason (and thus defensible), is extremely important. However, whether conduct will be tested on a per se basis or under the rule of reason is extremely complicated and often very difficult to predict, resting on based on how a court will interpret an extensive (and often inconsistent) mosaic of case law developed over the last century. This paper advocates a reassessment of the per se rule (the Rule ) in Section 1 cases, to require at least some proof that the parties to an agreement possess market power or that their conduct had anti-competitive effects in a particular market (market power and anticompetitive effects are typically considered as rough proxies for one another in antitrust analysis 2 ) before subjecting the parties to such severe penalties. My call for reassessment of the per se rule presents two principal arguments: (1) that the super per se test, rejecting proof of market power, developed in the 1940 Socony-Vacuum Oil decision needlessly broke with decades of Supreme Court precedent; and (2) that the three policy justifications (business 2 See, e.g., id. at 15-26; Indiana Dentists, infra note 78 at 457.

3 Casey W. Halladay William E. Swope Antitrust Prize Submission 3 efficiency, deterrence, and administrative efficiency) most commonly cited post-socony to defend the Rule have been overstated and are much-diminished in modern antitrust law. The paper proceeds in four parts. Part II examines the history and development of the per se rule, noting the anomalous appearance of which I have termed a super per se test (rejecting proof of market power) in the 1940 Socony-Vacuum Oil case, and suggests that the rule developed in Socony is no longer appropriate today. Part III traces the development of the Rule in the aftermath of Socony, particularly its reformulation by the Supreme Court in the 1980s following its landmark decision in Broadcast Music. 3 In its 1999 California Dental decision, 4 the Court appeared to reject the rigid per se/rule of reason dichotomy in favor of an analytical spectrum, applying at least some aspects of the rule of reason in every case. This more flexible approach may cure some of the defects of strict per se condemnation of horizontal conduct. Having examined the juridical flaws of the per se rule in Parts II-III, Part IV reviews (and critiques) the three most commonly cited defenses of the Rule business efficiency, deterrence, and administrative efficiency by arguing that these justifications have been overstated and, in many instances, no longer reflect the realities of modern-day antitrust litigation and criminal enforcement. Instead, the overbreadth of the rule may chill otherwise legitimate joint venture activity. An important principle underlying the arguments presented in this paper is the recognition that agreements between rivals which do not collectively possess market power pose no threat to markets. 5 Notwithstanding this realization, post-socony courts have nonetheless 3 Infra note Infra note See, e.g., AREEDA & HOVENKAMP, FUNDAMENTALS, supra note 1 at 15-43; the comments of Judge Bork in Rothery Storage & Van Co. v. Atlas Van Lines, Inc., 792 F.2d 210, 217 (DC Cir. 1986); and of Professor (as he then was) Posner in The Next Step in the Antitrust Treatment of Restricted Distribution: Per Se Legality, 48 U. Chi. L. Rev. 6, 16 (1981).

4 Casey W. Halladay William E. Swope Antitrust Prize Submission 4 persisted in the application of per se rules which, by their nature and the truncated analysis which they impose, may sweep in and criminalize such agreements. Furthermore, overdeterrence may have a chilling effect on otherwise legitimate joint venture activity. As Professor (now Judge) Easterbrook has observed, markets provide a more accurate and efficient check on such conduct than judges, since the market is better than the judicial process in discriminating the beneficial from the detrimental. Judges who try to assess the merits of the collaboration are apt to err, and the consequences of these errors will be one-sided. If judges condemn efficient practices, they will disappear, their benefits lost. If judges tolerate inefficient practices, the wrongly-tolerated practices will disappear under the onslaught of competition. The costs of judicial error are borne by consumers, who lose the efficient practices and get nothing in return. 6 Some commentators have gone so far as to claim that the market may be the preferred regulator for most practices reviewed under Section 1. 7 In Easterbrook s view, the existence of rivals who can stamp out bad practices faster than the judicial process can means that the approach to collaborations lacking market power should be one of no power, no problem. 8 II. Re-Examining the Origins of the Per Se Rule Have Modern Courts Gotten It Right? (1) Introduction Any argument for legal revision must consider the binding effects of precedent, which have often limited otherwise skeptical judges from changing the law. This concern was perhaps most famously applied to antitrust by Justice Stevens in Jefferson Parish, when he noted 6 Frank H. Easterbrook, The Limits of Antitrust, 63 Texas L. Rev. 1, 21 (1984). 7 See, e.g., Peter Nealis, Per Se Legality: A New Standard in Antitrust Adjudication Under the Rule of Reason, 61 Ohio St. L.J. 347 (2000). 8 Easterbrook, supra note 6 at (emphasis added).

5 Casey W. Halladay William E. Swope Antitrust Prize Submission 5 that it is far too late in the history of our antitrust jurisprudence to question the proposition that certain arrangements pose an unacceptable risk of stifling competition and therefore are unreasonable per se. 9 In a concurring opinion in the Topco Associates case, Justice Blackmun similarly lamented that the per se rule [ ] now appears to be so firmly established by the Court that, at this late date, I could not oppose it. 10 Such sentiments are not uncommon. Given this concern with the effects of precedent, an examination of the history of our antitrust jurisprudence provides a useful starting point for any reassessment of the per se rule. The results of this examination are very interesting, for the origins and application of the Rule raise some doubts as to it current application. The per se rule that survives in U.S. antitrust today is a judicial hand-me-down from another era. It first appeared, albeit in a more limited form, in Trenton Potteries, 11 and was later significantly (but unnecessarily) expanded in the Socony 12 decision. Prior to Trenton Potteries, most horizontal agreements had been prosecuted under Section 1 on the rule of reason. Perhaps the most famous of these early rule of reason cases was Chicago Board of Trade. 13 (2) Chicago Board of Trade Chicago Board of Trade involved a challenge brought by the Department of Justice against certain rules of the Chicago Board of Trade, then the world s largest grain exchange. In 1906, the Board adopted a call rule, which provided that all member purchases of grain to arrive (that is, grain shipments in transit to Chicago at the time of purchase) made after the 2 p.m. closing of the exchange s trading session would be made at the closing price of 9 Jefferson Parish, infra note 168 at Topco Associates, infra note 88 at Infra note Infra note Board of Trade of the City of Chicago et al. v. United States, 246 U.S. 231 (1918).

6 Casey W. Halladay William E. Swope Antitrust Prize Submission 6 grain. Active bargaining in prices for grain to arrive would resume upon opening of the exchange the following day. The Department of Justice sought to prosecute the case on what was effectively a per se standard. As described by Justice Brandeis in his decision, the DOJ: made no attempt to show that the rule was designed to or that it had the effect of limiting the amount of grain shipped to Chicago; or of retarding or accelerating shipment; or of raising or depressing prices; or of discriminating against any part of the public; or that it resulted in hardship to anyone. 14 Instead of leading evidence to demonstrate the anti-competitive effects of the call rule, the DOJ based its case solely on what Justice Brandeis termed a bald proposition, that a rule or agreement by which men occupying positions of strength in any branch of trade, 15 fixed prices at which they would buy or sell during an important part of the business day, is an illegal restraint of trade under the Anti-Trust law. But the legality of an agreement or regulation cannot be determined by so simple a test, as whether it restrains competition. 16 Although Justice Brandeis did not refer to the prosecution s approach as a per se rule against price-fixing agreements, in effect that is exactly what he described. He rejected this simple standard for Section 1 cases, stating rather that the true test of legality is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition. 17 In order to resolve this question, courts must consider the facts peculiar to the business to which the restraint is applied; its condition before and after the restraint was imposed; the nature of the restraint and its effects, 14 Id. at It is noteworthy that even in these early days, the DOJ s formulation of a per se standard required that some element of market power ( positions of strength in any branch of trade ) be proven. This approach to the per se rule is consistent with the position taken by the Supreme Court in all per se cases until the inexplicable departure from this standard in Socony. 16 Id. (emphasis added). 17 Id.

7 Casey W. Halladay William E. Swope Antitrust Prize Submission 7 actual or probable. 18 As more fully discussed in Part III below, Chicago Board of Trade adopted a rule of reason approach that was arguably broader than that required by courts today. Based on this standard, Justice Brandeis found relatively few potential anti-competitive effects (and several that were pro-competitive), and dismissed the case against the Board of Trade. (2) Trenton Potteries Having been shelved by a unanimous Supreme Court in Chicago Board of Trade, the per se rule re-emerged nine years later in Trenton Potteries. The Department of Justice charged and convicted twenty individual defendants and twenty-three corporations with fixing prices and limiting sales to particular customers in the market for vitreous pottery bathroom fixtures. The respondents controlled 82% of the market for such fixtures. At trial, the jury was instructed that it could return a guilty verdict without regard to the reasonableness of the prices fixed, or the good intentions of the combining units, whether prices were actually lowered or raised or whether sales were restricted to the special jobbers, 19 as the agreements themselves were unreasonable restraints. On appeal to the Supreme Court, the defendants challenged this jury instruction (and the trial judge s refusal to submit a jury charge based on the language of Chicago Board of Trade) as an error of law. In rejecting the defendants argument, Justice Stone offered the following observations about price-fixing agreements, which have since been cited in most cases (including Socony) as a basis for per se treatment of competitor agreements: [t]he aim and result of every price-fixing agreement, if effective, is the elimination of one form of competition. The power to fix prices, whether reasonably exercised or not, involves power to control the market and to fix 18 Id. 19 United States v. Trenton Potteries Co. et al., 273 U.S. 392, 395 (1927).

8 Casey W. Halladay William E. Swope Antitrust Prize Submission 8 arbitrary and unreasonable prices. The reasonable price fixed today may through economic and business changes become the unreasonable price of to-morrow [ ] Agreements which create such potential power may well be held to be in themselves unreasonable or unlawful restraints, without the necessity of minute inquiry whether a particular price is reasonable or unreasonable as fixed [ ] 20 Despite its subsequent usage as one of the major pillars underlying the per se rule for horizontal agreements, there are two important points which emerge from this passage (and from a thorough reading of Justice Stone s decision): first, that price-fixing or other agreements between competitors still required proof of market power before liability could attach and, second, that the evidentiary burden Trenton Potteries sought to avoid by adopting a per se rule related to proof that the prices fixed were unreasonable. On the first point, the court was very clear. Even the trial judge s jury instruction, which formed the basis for the defendants unsuccessful appeal, correctly noted that an illegal agreement must exist between the members of a combination controlling a substantial part of an industry. 21 After a detailed review of the Supreme Court s Section 1 jurisprudence, Justice Stone concluded that it has since often been decided and always assumed that uniform pricefixing by those controlling in any substantial manner a trade or business in interstate commerce is illegal despite the reasonableness of the prices agreed upon. 22 As is obvious from this statement, and several others throughout the decision, per se illegality for price-fixing required proof of the participants market power. This requirement was consistent with the policy evil the court was trying to remedy in this case preventing the reasonable price fixed today from becoming the unreasonable price of to-morrow. Absent market power, firms would not have the ability to sustain the unreasonable price of tomorrow. 20 Id. at (emphasis added). 21 Id. at Id. at 398 (emphasis added).

9 Casey W. Halladay William E. Swope Antitrust Prize Submission 9 These quotations also demonstrate beyond doubt that the purpose of the per se rule developed in Trenton Potteries was to prevent defendants from claiming that the price fixed was reasonable, thereby triggering a lengthy analysis into the functioning of markets and reasonableness of prices. Justice Stone clearly stated that we should hesitate to adopt a construction making the difference between legal and illegal conduct in the field of business relations dependent on so uncertain a test as whether prices are reasonable. 23 Thus, the per se rule was not invented as a means of avoiding proof of competitive effects or market power, as it is used today the intention was entirely the opposite, as the clear insistence on proving market power demonstrated. (4) Socony-Vacuum Oil All of this changed, however, with the Supreme Court s decision in Socony- Vacuum Oil 24 in The case involved a massive prosecution of 26 corporations and 46 individuals accused of price-fixing by participating in a program to purchase tank cars of gasoline in spot markets in the Midwest and East Texas at agreed-upon prices. The defendants were major integrated oil companies who, the Department of Justice alleged, purchased gasoline in excess of their needs from independent refiners in order to maintain artificially high prices. Suffering for more than a decade from massive oversupply and marketwide prices well below the cost of production, and with the encouragement of the Secretary of the Interior, the defendants established a Planning and Co-ordination Committee to stabilize the oil industry on a profitable basis. 25 A Marketing subcommittee subsequently formed to stabilize prices in 23 Id. 24 United States v. Socony-Vacuum Oil Co., 310 U.S. 150 (1940). 25 Id. at 172.

10 Casey W. Halladay William E. Swope Antitrust Prize Submission 10 regions particularly affected by the sale of hot or distress 26 gasoline. Ultimately, the defendants developed a plan by which each major oil company would be assigned one or more independent refiners (notoriously referred to as dancing partners ) and purchase any distress gasoline from those refiners at fair market prices. Evidence in the record suggested that, at least initially, there were discussions among the defendants as to what constituted a fair price. The ultimate result of the plan, as determined by Justice Douglas, was not merely to raise the spot market prices [i.e. the prices charged by the independent refiners] but, as the real and ultimate end, to raise the price of gasoline to jobbers and consumers in the Mid-Western area. 27 At trial, the defendants were convicted under Section 1. The jury charge indicated that where the defendants controlled a substantial part of the interstate trade and commerce in that commodity, had the power to raise prices, and acted together for that purpose, the combination was illegal and that it was immaterial how reasonable or unreasonable those prices were. 28 As one would expect, this jury instruction was entirely consistent with the holding in Trenton Potteries, even to the level of indicating that the purpose of per se treatment was to avoid an inquiry into the reasonableness of the price fixed. On appeal to the Seventh Circuit, the court held the jury charge to be reversible error since it was based upon the theory that such a combination was illegal per se. 29 A majority of the Supreme Court disagreed with this conclusion, reversing the Seventh Circuit and restoring the District Court s judgment. Justice Douglas considered the 26 Hot gasoline was product sold in violation of state price control legislation. Distress gasoline refers to that product for which the refiner had neither storage capacity nor a regular sales outlet. Such product therefore had to be sold for whatever price, however low, it would bring on the market. 27 Socony, supra note 24 at Id. at Id.

11 Casey W. Halladay William E. Swope Antitrust Prize Submission 11 defendants arguments, particularly their contention that the price stabilization program had enjoyed tacit, if not explicit, government approval and had in fact contributed to some stabilization in gasoline prices. He countered by stating that: this Court has consistently and without deviation adhered to the principle that price-fixing agreements are unlawful per se under the Sherman Act and that no showing of so-called competitive abuses or evils which those agreements were designed to eliminate or alleviate may be interposed as a defense. 30 The latter part of this quotation is extremely important, but often overlooked in subsequent cases. It makes clear that, to this point in his decision at least, Justice Douglas viewed the per se rule as prohibiting defendants from raising policy arguments (e.g., stabilizing prices for an essential commodity such as gasoline) to justify price-fixing. 31 His reference to the Appalachian Coals 32 and Sugar Institute 33 cases, in which competitive abuses defenses were not permitted, confirms this interpretation. Furthermore, this view was entirely consistent with the principles of Trenton Potteries, where the defendants were prohibited from raising similar policy defenses (i.e., that the prices fixed were reasonable). However, the majority then proceeded, unnecessarily, to expand the per se rule beyond the boundaries of precedent. Under the per se test from Trenton Potteries, there was already sufficient evidence in the record to sustain the District Court s conclusion, since: (i) the jury found as fact that the defendants had entered into the prohibited agreement; and (ii) the 30 Id. at 218 (emphasis added). 31 His judgment contains many similar statements, concluding that the elimination of so-called competitive evils is no legal justification for such buying programs and if the so-called competitive abuses were to be appraised here, the reasonableness of prices would necessarily become an issue in every price-fixing case : see id. at 220, 221 (emphasis added). The latter statement is again consistent with the policy rationale for the per se rule developed in Trenton Potteries to prevent inquiries into the reasonableness of fixed prices. The former statement appears consistent with a common theme endorsed by antitrust courts, that arguments predicated on the notion that competition is bad for a given industry will not be accepted. For a more recent example see, e.g., Professional Engineers, infra note Appalachian Coals, Inc. v. United States, 288 U.S. 344 (1933). 33 Sugar Institute, Inc. v. United States, 297 U.S. 553 (1936).

12 Casey W. Halladay William E. Swope Antitrust Prize Submission 12 defendants controlled a substantial part of the industry, as they possessed an 83% market share in the region. 34 In a passage which later became the foundation for eliminating market power and competitive effects analysis under the per se rule, the decision proceeded into obiter and stated that: the thrust of the rule is deeper and reaches more than monopoly power. Any combination which tampers with price structures is engaged in unlawful activity. Even though the members of the price-fixing group were in no position to control the market, 35 to the extent that they raised, lowered or stabilized prices they would be directly interfering with the free play of market forces. The Act places all such schemes beyond the pale and protects that vital part of our economy against any degree of interference. 36 This unfortunate language is the basis of what could be described, in comparison with the Trenton Potteries standard, as a super per se test, which excludes consideration of market power and competitive effects for certain competitor agreements. (5) Re-examining the Socony Legacy The above passage of Socony merits reassessment on at least three different levels, relating to its legal significance, its policy significance, and the unique historical context in which the decision was rendered. As to its legal significance, the result in Socony, or at least that portion of the decision relating to agreements lacking market power, is ripe for review. As noted above, the passage in question was obiter dicta, as it was unnecessary to resolve the questions before the court. Perhaps worse, it represented an explicit departure from the Supreme Court s prior 34 Socony, supra note 24 at The apparent gap between this statement, and the earlier finding that the parties controlled 83% of the relevant market, is not explored in Justice Douglas decision. 36 Socony, supra note 24 at 221 (emphasis added).

13 Casey W. Halladay William E. Swope Antitrust Prize Submission 13 jurisprudence, which had always required proof of market power ( control of a substantial portion of a trade ) in Section 1 cases, without providing any reasoned basis for doing so. 37 As such, that passage could today be considered outside the scope of binding precedent by courts. It is suggested that, in light of the other arguments raised in this paper, future courts consider distinguishing the application of Socony on this basis. Regarding the policy significance of the decision, although many subsequent commentators 38 have offered justifications for the imposition of a per se rule that ignores market power and competitive effects, the Socony court offered none. 39 Neither is it apparent, at least from a reading of the decision, that the Department of Justice put such an argument to the court. It is regrettable that such a significant decision was taken without at least some argument devoted to the matter by counsel. Furthermore, it appears that Justice Douglas may have raised the issue in response to the defendants argument that (despite their overwhelming collective market share) they could not control prices due to various regulatory conditions and economic forces beyond their control. If so, such rebuttal may not have been intended to set a new legal standard for the prosecution of Section 1 cases. The legal landscape in which Socony was decided has also changed significantly. In 1940, Section 1 of the Sherman Act was a misdemeanor with maximum penalties of $5000 and/or one year imprisonment. 40 The District Court fined the accused corporations $5000 each, 37 A similar departure from precedent in the Schwinn case, infra note 50, drew criticism from Justice Powell in the groundbreaking GTE Sylvania decision, infra note 49 at 47, 51: Schwinn itself was an abrupt and largely unexplained departure from White Motor Co. v. United States [ ] only four years later the Court in Schwinn announced its sweeping per se rule with [ ] no explanation of its sudden change in position. See also Chief Justice Burger s lengthy review of per se treatment of market allocation agreements in concluding that the majority opinion established a new per se rule that should not be followed in Topco Associates, infra note 88 at See, e.g., Areeda & Hovenkamp, supra note 1 at 15-43, and the discussion at Part IV below. 39 Importantly, Professors Areeda and Hovenkamp concur that, other than an explanation of why inquiry into the reasonableness of prices should not be permitted, [t]he Socony court did not further elaborate the rationale for invoking costly prosecutorial machinery and punishing those who cause no harm : see id. at Socony, supra note 24 at 165, n3.

14 Casey W. Halladay William E. Swope Antitrust Prize Submission 14 and each individual accused $1000. However, in 1974 Section 1 was recast as a felony offence, 41 with maximum penalties including fines of up to $10,000,000/$350,000 (for corporations/individuals) and/or 3 years imprisonment. Prison sentences for individual accused in recent years have been common. 42 Even more significantly, in 2004 the Justice Department sought and obtained major increases in the maximum penalties under Section 1 to fines of $100,000,000/$1,000,000 (corporate/individual) and/or 10 years imprisonment. 43 It is no longer appropriate to apply a super per se standard of liability developed sixty-five years ago for misdemeanor conduct, in an era when jail sentences were rarely imposed for antitrust offences, 44 to felony conduct carrying serious criminal penalties today. While the statutory penalties available under Section 1 have been modernized, the test for applying them has not. 45 Finally, it is interesting to consider the unique historical and political context in which the Socony court created its super per se test. Justice Douglas issued his opinion on May 6, 1940, at an extremely anxious moment in the nation s history. German armies had captured Western Europe with alarming speed and, while the U.S. was not at war, the question of entering the war was debated daily. The defendants before him had manipulated prices for gasoline, arguably the nation s most valuable wartime commodity, as part of a conspiracy that affected the entire US Midwest and included virtually every significant oil company operating in the region. One is left to wonder what effect, if any, these circumstances had on his decision to depart from the Trenton Potteries precedent and impose a new and stricter test for cartel offences. Other commentators have noted that the decision may also have been the product of a 41 Antitrust Procedures and Penalties Act, Pub.L , 3, 88 Stat See the discussion of penalties under Section 1 and examples provided at Part IV(3), below. 43 Development and Promulgation of Voluntary Consensus Standards Act, Pub.L , Title II, 215(a), 118 Stat See, e.g., the discussion of this point in Donald I. Baker, The Use of Criminal Law Remedies to Deter and Punish Cartels and Bid-Rigging, 69 Geo. Wash. L. Rev. 693, (2001). For instance, Baker notes that as late as the 1960s, judges rarely sentenced individuals to jail, even when the DOJ recommended a jail sentence. 45 For a summary of legislative amendments to the penalty clause in Section 1, see Part IV(3) below.

15 Casey W. Halladay William E. Swope Antitrust Prize Submission 15 renewed interest in Washington to promote competition policy over the New Deal economic planning of the 1930s. 46 The foregoing discussion traces the early development of the per se rule and demonstrates that market power had been an essential element in Section 1 cases decided under both the per se and rule of reason standards. It is intended to show that the departure from this norm in Socony could be revisited by future courts to avoid strict application of the per se rule in cases that otherwise would traditionally be caught by it. Such justification should perhaps not be necessary. The Supreme Court itself has acknowledged, in departing from the per se rule in other circumstances, that stare decisis is not an inexorable command especially in the area of antitrust, where there is a competing interest, well represented in this Court s decisions, in recognizing and adapting to changed circumstances and the lessons of accumulated experience. 47 However, this historical analysis may provide future courts a reasoned basis for distinguishing and limiting the application of the per se test from Socony. As explored in Part III below, the Supreme Court s increasing willingness over the past twenty-five years to move towards a more flexible, less categorical approach to the per se rule (to include an examination of market power) should also encourage future courts to do so. 46 See, e.g., William E. Kovacic & Carl Shapiro, Antitrust Policy: A Century of Economic and Legal Thinking, 14 J. Econ. Persps. 43, (2000). The authors note (at 50) that [i]n hindsight, Socony s ban upon all arrangements that affect price seems extreme, but its aim in 1940 was to reaffirm the primacy of competition and revitalize the Sherman Act. 47 State Oil Company v. Khan, 522 U.S. 3, 520 (1997). See also Professors Areeda and Hovenkamp s view that the doctrine of stare decisis does not account satisfactorily for judicial commitment to a particular antitrust rule of analysis, supra note 1 at

16 Casey W. Halladay William E. Swope Antitrust Prize Submission 16 III. Recent Trends Indicate a Movement Towards Rule-of-Reason Analysis (1) Introduction Many commentators 48 have observed that in the late 1970s, the US Supreme Court began to analyze Section 1 cases with greater reliance (either explicitly or implicitly) on the rule of reason, and less emphasis on labeling conduct as per se illegal. The 1979 Broadcast Music decision, discussed below, is often credited as the landmark ruling that began this process, but traces of the new approach had already appeared by the time Broadcast Music came before the court. In the 1977 GTE Sylvania case, 49 the court explicitly rejected the treatment of nonprice vertical restraints under the per se rule, overruling its prior decision in Schwinn. 50 In so doing, Justice Powell foreshadowed the emerging trend with his observation that departure from the rule-of-reason standard must be based upon demonstrable economic effect rather than as in Schwinn upon formalistic line-drawing. 51 The following year, the court reviewed a profession-wide ban on competitive bidding in the Professional Engineers case. 52 The Ethical Code of the National Society of Professional Engineers prohibited its 69,000 members from providing price quotes or otherwise negotiating fees with potential clients until the client had chosen an engineer for a project. Where a potential client insisted on the provision of pricing information, the Code required members to withdraw from consideration for the project. Although the case appeared to be a clear candidate for per se condemnation under Socony with the Society conceding that its rules prevented competitive pricing the court chose to review the case under the rule of 48 See, e.g., ROBERT BORK, THE ANTITRUST PARADOX: A POLICY AT WAR WITH ITSELF xiii (The Free Press, 1993) (1978); and the comments of Justice Posner in Jack Walters & Sons Corp. v. Morton Bldg., Inc., 737 F.2d 698, 707 (7th Cir. 1984). 49 Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36 (1977). 50 United States v. Arnold, Schwinn & Co., 388 U.S. 365 (1967). 51 GTE Sylvania, supra note 47 at (emphasis added). 52 Nat. Society of Professional Engineers v. U.S., 435 U.S. 679 (1978).

17 Casey W. Halladay William E. Swope Antitrust Prize Submission 17 reason. It considered at some length, before ultimately rejecting, the Society s defense that the ban on competitive bidding served the public interest by preventing the cost-cutting and inferior quality construction that might result from low-price bids. 53 Based on the text of Justice Stevens majority opinion, the court did not even consider application of the per se rule, although it was the basis for the District Court s condemnation of the Code bidding restraints at trial. 54 The court s departure from the per se rule in Broadcast Music the following year, and again in N.C.A.A., was explicit and, along with similar departures from per se treatment in other cases of that era, 55 began a gradual movement towards analysis more focused on markets and competitive effects than on the categorization of conduct along lines imposed by precedent. As explored more fully below, this evolution reached its apex in the California Dental case, with the development of a sliding analytical scale to assess (if at least briefly) competitive effects in all cases. (2) Broadcast Music In Broadcast Music, 56 the Supreme Court began a march away from the strict categorization of Section 1 cases into per se or rule of reason offences. Perhaps influenced by a 53 Justice Stevens noted that the rule of reason is based on an evaluation of the economic justifications for allegedly anti-competitive conduct, as opposed to policy justifications (for which Congress is responsible). In his view, petitioner s attempt to [justify the bidding restraints] on the basis of the potential threat that competition poses to the public safety and the ethics of its profession is nothing less than a frontal assault on the basic policy of the Sherman Act : id. at Id. at 681: the District Court rejected [the Society s defense] without making any findings on the likelihood that competition would produce the dire consequences foreseen by the association. 55 See, e.g., the addition of a market power requirement to the per se test for: (i) tying, in Jefferson Parish, infra note 168; (ii) group boycotts by a purchasing co-operative, in Northwest Wholesale Stationers v. Pacific Stationers, 472 U.S. 284, (1985); and, arguably, (iii) group boycotts generally, in Indiana Dentists, infra note 78 at 458: [a]lthough this court has in the past stated that group boycotts are unlawful per se [citations omitted], we decline to resolve this case by forcing the Federation s policy into the boycott pigeonhole and invoking the per se rule. 56 Broadcast Music, Inc. v. Columbia Broadcasting, 441 U.S. 1 (1979).

18 Casey W. Halladay William E. Swope Antitrust Prize Submission 18 growing wave of criticism, led by the Chicago School academics, 57 that antitrust was unnecessarily rigid (to the point of chilling efficient or otherwise pro-competitive conduct), the court refused to condemn conduct that seemingly should have been prohibited under the per se standard from Socony. The case involved a challenge by television broadcaster CBS against ASCAP (the American Society of Composers, Authors and Publishers) and BMI (Broadcast Music, Inc.), two performing rights societies formed by thousands of individual owners of copyrighted musical works to overcome the collective action problem of negotiating licenses to use, and detected unlicensed use of, their music. BMI and ASCAP operated in similar fashion, negotiating blanket licenses with radio stations, television broadcasters and other large-scale users of copyrighted music in exchange for a flat fee. Collectively, BMI and ASCAP s musical repertories contained nearly every copyrighted musical composition in the United States. CBS, a longtime licensee of both BMI and ASCAP and a former founder of BMI, argued that both societies had engaged in per se illegal price fixing contrary to Section 1 by selling blanket licenses to all copyrighted music for a flat fee instead of negotiating prices for individual compositions. 58 At trial, the District Court ruled that the societies practices did not fall within the per se rule and, ultimately, dismissed the complaint. The Second Circuit reversed, holding the conduct to be per se illegal. On further appeal to the Supreme Court, Justice White held the rule of reason to be the appropriate standard of review and remanded the matter for 57 See, for example, the forceful (and persuasive) criticism of Professor Bork in The Antitrust Paradox, supra note 48 at 4-8. He notes, inter alia, that at the time of writing (1978) many courts seem to recognize that the per se rules of illegality for all price-fixing and market division agreements are out of kilter, that something valuable may be lost : id. at In reflecting on the evolution of antitrust, Professor Baker has noted that the Chicago School revolution of the last twenty years uprooted and discarded, old, oversimplified per se rules and rubrics because they discouraged efficient conduct : see Jonathan B. Baker, Vertical Restraints With Horizontal Consequences: Competitive Effects of Most-Favored-Customer Clauses, 64 Antitrust L.J. 517, 517 (1996). 58 CBS raised several other antitrust challenges, alleging that the defendants conduct also constituted monopolization, unlawful tying and concerted refusal to deal. The Supreme Court s decision focused on the pricefixing allegation.

19 Casey W. Halladay William E. Swope Antitrust Prize Submission 19 further consideration. In reaching this conclusion, he made a number of interesting observations about the nature of the per se rule that initiated a retreat from strict application of the Rule. The blanket licenses, which provided access to many different artists musical compositions for a single flat fee, arguably fixed the price of competing products. Based on the broad Socony characterization of the Rule, this conduct should have been sufficient to merit per se condemnation, regardless of the competitive justifications or efficiencies which the arrangement generated. However, in reaching the opposite conclusion, Justice White began by noting that: price-fixing is a shorthand way of describing certain categories of business behavior to which the per se rule has been held applicable. The Court of Appeal s literal approach does not alone establish that this particular practice is one of those types or that it is plainly anticompetitive and very likely without redeeming virtue. Literalness is overly simplistic and often overbroad. 59 These comments, which suggest individualized analysis of particular competitor agreements, stand in stark contrast to Justice Douglas view in Socony that any combination which tampers with price structures is engaged in an unlawful activity. 60 In a telling passage, Justice White took the opposite position, stating that not all agreements among actual or potential competitors that have an impact on price are per se violations of the Sherman Act or even unreasonable restraints. 61 He then indicated that some price-fixing agreements may not be the sort of per se illegal price-fixing that Section 1 condemns summarily. In his opinion, it is necessary to characterize the challenged conduct as falling within or without that category of behavior to 59 Broadcast Music, supra note 56 at Socony, supra note 24 at Broadcast Music, supra note 56 at 23.

20 Casey W. Halladay William E. Swope Antitrust Prize Submission 20 which we apply the label per se price fixing. 62 He observed, with what one judicial commentator has since described as Pollyanna-like optimism, 63 that making this distinction will often, but not always, be a simple matter. 64 The test for determining whether or not the per se rule should be applied to particular conduct is to ask whether the practice facially appears to be one that would always or almost always tend to restrict competition and decrease output. 65 This new test represented a sharp departure from the Socony standard of per se prohibition of any agreement affecting prices or output, and provided a platform for the Supreme Court s increasingly detailed review of cases that might previously have merited immediate condemnation. One observer has described Broadcast Music as: the end of the per se rule as an administrative short-cut, at least in all but the most obvious cases. It heralded an era where the per se rule does not even apply to all price-fixing or market allocation agreements, much less other practices that were once thought to be off-limits. An assessment of the actual or likely market and efficiency effects of the practice now must precede final characterization. 66 Following the Maricopa 67 case, in which a 4-3 majority of the Court seemed intent on reversing course, the Broadcast Music approach reappeared in the N.C.A.A. case. (3) N.C.A.A. N.C.A.A. 68 involved a challenge by the University of Oklahoma, an NCAA member institution and one of the nation s leading college football programs, to the NCAA television plan for college football games. The basic elements of the plan at issue involved: (i) 62 Id. at Diane P. Wood, The Incredible Shrinking Per Se Rule: Is An End In Sight? 2 (conference paper prepared for the American Bar Association Section of Antitrust Law Annual Spring Meeting, March 2004). Madame Justice Wood is a Judge of the Seventh Circuit Court of Appeals. 64 Broadcast Music, supra note 56 at Id. at Wood, supra note 63 at Arizona v. Maricopa Country Medical Society et al., 457 U.S. 332 (1982). 68 N.C.A.A. v. Bd. Of Regents of Univ. of Okl., 468 U.S. 85 (1984).

21 Casey W. Halladay William E. Swope Antitrust Prize Submission 21 exclusive broadcast agreements with ABC and CBS for a fixed minimum level of compensation, with individual recommended fees for national and regional broadcasts set by the NCAA; (ii) appearance requirements mandating coverage of at least 82 different member schools, with a maximum of six appearances per school; and (iii) an overall limit of the number of games that could be televised during the life of the contracts with ABC and CBS. NCAA schools were forbidden from negotiating individual contracts with broadcasters under threat of sanctions (which were not limited to the offending school s football program, but could apply to all sports). Petitioner University of Oklahoma succeeded at trial, with the District Court finding the television plan inconsistent with Section 1 as it fixed prices for telecasts, restricted output by limiting the number of games to be broadcast, and constituted a boycott of other broadcasters. On appeal, the Tenth Circuit found the plan to be per se illegal price-fixing. The Supreme Court resolved the case under the rule of reason. Citing with approval the new per se test from Broadcast Music (that the Rule is to be applied only where the practice facially appears to be one that would always or almost always tend to restrict competition and decrease output ), Justice Stevens chose not to apply it despite acknowledging that the television plan did restrict output and fix prices. Instead, he stated that it would be inappropriate to apply a per se rule to this case since this case involves an industry in which horizontal restraints on competition are essential if the product is to be available at all. 69 He therefore adopted a very restrained approach to the use of the per se rule (unlike his earlier decision in Maricopa), particularly given the court s acceptance that the restraints were not required in order to make the product (televised college football) available. 69 Id. at

22 Casey W. Halladay William E. Swope Antitrust Prize Submission 22 Apart from some unhelpful (and rather unnecessary 70 ) remarks about the lack of a market power requirement under the per se rule, the majority decision continued the Broadcast Music trend of de-emphasizing the per se/rule of reason dichotomy. In particular, Justice Stevens indicated that whether the ultimate finding is the product of a presumption [per se] or actual market analysis [rule of reason], the essential inquiry remains the same whether or not the challenged restraint enhances competition. 71 In an oft-quoted passage considered to be the origin of the quick look rule of reason analysis confirmed in California Dental (see below), Justice Stevens noted that the essential point is that the rule of reason can sometime be applied in the twinkling of an eye. 72 In the end, the majority condemned the NCAA television plan, but did so under a thorough rule of reason analysis a very progressive outcome, given the obvious price-fixing and output-reducing aspects of the plan. (4) California Dental In California Dental, 73 the Supreme Court clarified the evolution of the per se/rule of reason dichotomy in its jurisprudence in the twenty years since Broadcast Music. The case involved a Federal Trade Commission challenge to advertising limitations imposed by the California Dental Association (CDA), a voluntary, non-profit association of local dentist societies comprising 75% of all dentists practicing in California. Specifically, the FTC held that the CDA s rules on advertisements relating to pricing and quality created per se illegal restraints on competition among dentists. On appeal to the Ninth Circuit, the court again condemned the 70 The observations about market power were unnecessary given Justice Stevens acknowledgement that it is evident that petitioner does possess market power : id. at Id. at 104 (emphasis added). He continued, in a footnote to this passage, as follows: [i]ndeed, there is often no bright line between separating per se from Rule of Reason analysis. Per se rules may require considerable inquiry into market conditions before the evidence justifies a presumption of anticompetitive conduct. 72 Id. at 109, n39, quoting P. Areeda, The Rule of Reason in Antitrust Analysis: General Issues (Federal Judicial Center, June 1981). 73 Cal. Dental Ass n v. Federal Trade Com n, 526 U.S. 756 (1999).

23 Casey W. Halladay William E. Swope Antitrust Prize Submission 23 advertising restrictions, but did so using an abbreviated, or quick look, rule of reason analysis, following N.C.A.A. 74 The Supreme Court granted certiorari in order to resolve conflicts among the Circuits on [ ] the occasions for abbreviated rule-of-reason analysis. 75 Writing for the majority, 76 Justice Souter held that the Court of Appeals erred in applying a quick look instead of full rule of reason analysis. In tracing the origins of the quick look rule, he cited N.C.A.A., Professional Engineers 77 and Indiana Dentists 78 as the foundation of an abbreviated or quick-look analysis under the rule of reason, [from which] an observer with even a rudimentary understanding of economics could conclude that the arrangements in question would have an anticompetitive effect on customers and markets. 79 Each of these cases involved horizontal restrictions among competitors that appeared to be per se illegal under the Socony test, but were nonetheless resolved on what the court described in California Dental as the quick look rule of reason standard. That standard is to be applied where the great likelihood of anticompetitive effects can easily be ascertained. 80 Presumably, the parties must possess market power, or the ability to easily obtain it, for anticompetitive effects to be easily ascertainable, for as courts and countless authors 74 Id. at Id. at Interestingly, although the minority (Justices Breyer, Stevens, Kennedy and Ginsburg) disagreed as to the outcome of the case, and would have upheld the Ninth Circuit s decision, they did not disagree on the flexible analytical approach taken by the majority. Justice Breyer emphasized that the form of analysis I have followed is not rigid; it admits of some variation according to the circumstances [ ] [it] represents an effort carefully to blend the procompetitive objectives of the law of antitrust with administrative necessity. It represents a considerable advance from the days when the Commission had to present and/or refute every possible fact and theory, and from antitrust theories so abbreviated as to prevent proper analysis (emphasis added). 77 Supra note FTC v. Indiana Federation of Dentists, 476 U.S. 447 (1986). 79 California Dental, supra note 73 at Id.