Requiem for a Lightweight: How NCAA Continues to Distort Antitrust Doctrine, 56 Wake Forest L. Rev. _____ (2021) (forthcoming)

To download the latest version of this paper, go to this link.  

Abstract

The Supreme Court speaks rarely about the meaning of the Sherman Act.  When the Court does speak, its pronouncements have particular resonance and staying power among jurists, scholars and enforcers.  NCAA v. Board of Regents of the University of Oklahoma was such a case.  There the Court assessed agreements reducing the output and increasing the prices of televised college football games.  After announcing that restraints imposed by sports leagues are exempt from per se condemnation, the Court went on to invalidate the challenged agreements under the Rule of Reason because they produced significant economic harm without offsetting benefits.  In so doing the Justices also addressed restraints not before the Court, opining that members of the NCAA may collectively restrict the level of compensation that universities provide student athletes. 

Announced almost four decades ago, NCAA and its rationale have exerted substantial influence on Sherman Act doctrine, enforcement policy and scholarly discourse well beyond the context of sports leagues.  Later this term, in NCAA v. Alston, the Court will revisit the antitrust propriety of collective limitations on the compensation schools pay student athletes.  There the Court will review the Ninth Circuit’s condemnation of NCAA regulations restricting the value of education-related benefits, such as post-graduation scholarships, that schools provide student athletes in addition to tuition, room, board and other costs of attendance. 

While antitrust scholars and practitioners disagree about the merits of the Ninth Circuit’s decision, all hope the Court will clarify the extent to which the NCAA may limit student athlete compensation.  This essay contends that Alston also presents the Court with an opportunity to address more fundamental questions.  That is, the case offers the Court a chance to correct NCAA’s erroneous application of the per se standard and derivative errors the Court committed when conducting rule of reason analysis, errors that reverberate throughout Sherman Act jurisprudence.

  In particular, the essay demonstrates that NCAA’s sports league exemption from the ordinary per se standard contradicts basic antitrust principles.  Moreover, the rationale for the exemption turned partly on the Court’s (correct) assertion that some horizontal restraints can overcome market failures and enhance interbrand competition.  Recognition of these potential benefits undermined the Court’s otherwise broad articulation of the per se rule that purportedly created the need for such an exemption in the first place. 

  Failure to condemn the restraints before it as unlawful per se also distorted the Court’s pronouncements regarding how to conduct rule of reason analysis.  For instance, the requirements for establishing a prima facie case should depend upon the nature of redeeming virtues a restraint might produce.  However, courts, agencies and scholars have read NCAA as holding that proof that a restraint produces prices exceeding the non-restraint baseline necessarily establishes such a case, even when the restraint may overcome a market failure.  Moreover, lower courts, agencies and the Court itself have read NCAA as endorsing a “Quick Look” approach in some rule of reason cases, allowing plaintiffs to bypass any requirement to establish anticompetitive harm.  Finally, the Court’s approach to rule of reason analysis lent credence to the dubious assumption that benefits produced by challenged restraints necessarily coexist with harms, bolstering the equally dubious less restrictive alternative test.  Hopefully, the Court will take this opportunity in Alston to correct these errors and ensure a more coherent Section 1 jurisprudence that better reflects the teachings of modern economic theory.

Happy Birthday to United States v. Arnold Schwinn & Co., 388 U.S. 365 (1967)!

     

Vox Clamantis in Deserto (circa 1966)

Fifty-three years ago today the Supreme Court released its opinion in United States v. Arnold Schwinn & Co., 388 U.S. 365 (1967).  The decision banned exclusive territories and other non-price intrabrand restraints as unlawful per se, unless the manufacturer that obtained the restrictions retained title to the products governed by the restraint.  Schwinn exemplified the inability of expert enforcement agencies to absorb recent insights from lower court decisions and evolving economic theory necessary to understand the actual economic impact of non-standard contracts.  This post describes the jurisprudential background of Schwinn as well as the role (or not) that evolving economic theory played in motivating and informing the decision.

1.   The Sherman Act prohibits contracts "in restraint of trade of trade or commerce among the several States."  In Standard Oil v. United States, 221 U.S. 1 (1911), the Supreme Court held that the Act prohibits only those agreements that restrain trade "unreasonably."  (For a detailed summary of the Standard Oil decision, go here.)  A restraint was unreasonable, in turn, if it produced monopoly or the consequences of monopoly.  The Court defined these negative consequences as higher prices, reduced output and/or reduced quality.  The Court also identified two categories of unreasonable agreements.  Those unreasonable because of their "nature or character," and those unreasonable because of the "surrounding circumstances."  Modern courts refer to restraints in the first category as "unlawful per se."  Courts assess restraints that are not unlawful per se under a fact-intensive Rule of Reason.

2.     Contracts are unlawful per se if they are part of a category of agreements that: (1) produce a "pernicious effect on competition" and, in addition, (2) "lack any redeeming virtues."  See Northern Pacific Railway Co. v. United States, 356 U.S. 1, 5-6 (1958).   When implementing this standard, the Court has effectively equated a pernicious effect on competition with any reduction in rivalry between the parties to the restraint.  As a result, the outcome of the application of this standard almost always turns on whether restraints in the given category could produce "redeeming virtues."  See Alan J. Meese, Price Theory, Competition and the Rule of Reason, 2003 Illinois L. Rev. 77, 96.   Both mergers and naked price fixing extinguish competitive rivalry.  But mergers survive per se condemnation because they may produce redeeming virtues.

3.   During the 1950s and 1960s, the nation's expert enforcement agencies condemned non-price intrabrand restraints, both horizontal and vertical, regardless of the market position of the parties.  For instance, the FTC challenged exclusive territories obtained by Sandura, a struggling manufacturer of vinal floor covering products.  See Sandura Co. v. FTC, 339 F.2d 847 (6th Cir. 1964).    The Department of Justice challenged exclusive territories and reservations of customers obtained by the White Motor Company.  See White Motor Co. v. United States, 372 U.S. 253 (1963).   Both agencies claimed that such restraints reduced rivalry (as they certainly did) and could not produce redeeming virtues, with the result that both deserved per se condemnation.

       Such restraints would later become known as non-standard contracts, because they did more than just mediate passage of title between buyer and seller.  See Oliver E. Williamson, Assessing Contract, 1 J. L., Econ. & Org. 177, 185-188 (1985) (distinguishing "classical market contracting" from "nonstandard contracts" such as tying, franchise restrictions, customer and territorial restrictions, minimum rpm and exclusive dealing).  The agencies' condemnation of these and other non-standard contracts flowed naturally from the dominant economic framework of the time, so-called Neoclassical Price Theory.  As the late Oliver Williamson explained, Price Theory only recognized technological efficiencies.  By their nature, these efficiencies, such as economies of scale, arose solely within the boundaries of a firm.  This incomplete and erroneous account of efficiencies precluded economists from recognizing that non-standard contracts that limited the discretion of trading partners after passage of title could produce cognizable benefits.   Such agreements all reduce competitive rivalry one way or the other.  Because economists and others could not imagine any beneficial consequences of such restraints, they naturally inferred that firms entered such agreements in an effort to obtain or exercise market power.  Put in legal terms, such agreements had a pernicious effect on competition and lacked any redeeming virtues.  See Northern Pacific Railway Co.  The result was the so-called "Inhospitality Tradition" of antitrust law, whereby courts and agencies presumed all non-standard agreements unlawful and very rarely allowed rebuttal of this presumption.  See Oliver E. Williamson, The Economics of Governance, 95 Amer. Econ. Rev. 1, 5 n. 8 (2005) (describing origins of this term) (citing Alan J. Meese, Intrabrand Restraints and the Theory of the Firm, 83 N.C. L. Rev. 5 (2004))

4.   Beginning in 1960, economists and law professors began to push back against Price Theory's account of non-standard contracts.  In 1960, Lester Telser famously argued that minimum resale price maintenance could prevent a manufacturer's dealers from free riding on each others' promotional expenditures and thus ensuring appropriate expenditures on advertising and promotion.  Six years later, Robert Bork (pictured above) contended that exclusive territories were properly understood as ancillary restraints.  See The Rule of Reason and the Per Se Concept: Price Fixing and Market Division II, 75 Yale L. J. 373 (1966).  This under-appreciated article rehabilitated William Howard Taft's doctrine of ancillary restraints, giving the doctrine economic content within a normative framework of wealth maximization.  See United States v. Addyston Pipe & Steel Co., 85 F. 271 (6th Cir. 1899).   Bork also invoked Ronald Coase's conclusion that business firm are simply a particular form of contractual integration and opined that partial contractual integration could perform the same function as complete integration.  See Bork, Price Fixing and Market Division, 75 Yale L. J. at 384, n. 29 (citing Ronald H. Coase, The Nature of the Firm, 4 Economica (n.s.) 318 (1937)).  See also Alan J. Meese, Robert Bork's Forgotten Role in the Transaction Cost Revolution, 79 Antitrust L. J. 953 (2014).  Fully-integrated manufacturers naturally engaged in profit-maximizing advertising and promotion without incurring antitrust liability.  However, some manufacturers might choose to rely upon independent dealers to distribute their products. Granting such dealers an exclusive territory, Bork said, would allow dealers to capture the benefits of their promotional investments, thereby inducing such dealers to engage in the same amount and type of promotion as a fully-integrated firm.  (For additional elaboration of Bork's contributions to Antitrust thinking, see here).

5.   Even before Bork's breakthrough lawyers were making similar arguments about the propensity of such restraints to produce redeeming virtues.  In White Motors, for instance, the defendants contended that exclusive territories would ensure that "dealers who have spent valuable time 'pre-selling' a customer --- i.e., softening him up for a White sale instead of a GM or Ford sale --- will not lose the legitimate reward of their labor to another White dealer who jumps territorial boundaries at a strategic moment and snatches away the pre-sold customer."  Sandura echoed these contentions in an amicus brief filed in White Motors.  The company described its efforts to recruit new distributors in an effort to reverse competitive failure.  Such distributors, it said, would have to do "an extensive job of promoting [the product]" and "pay for the bulk of advertising and other promotional expenditures." (p. 8)   Exclusive territories, the company said, would ensure that dealers could capture the benefits of such investments.  Id.

6.  These arguments thwarted the agencies' efforts to extend the per se rule to these restraints.  In White Motor the Court refused to the declare the challenged restraints unlawful per se.  Although the Court did not expressly mention the problem of free riding, it did opine that such restraints "may be allowable protections against aggressive competitors or the only practicable means a small company has for breaking into a staying in business."  Id. at 263.   The Court thus rejected the Department's claim that such restraints could never produce redeeming virtues, because it did "not know enough about the economic and business stuff out of which these arrangements emerge to be certain."  Id. at 263.  Instead, it remanded to the district court for additional findings on this question.  Shortly thereafter, in Sandura, the Sixth Circuit rejected the FTC's contentions.  The court observed that "distributors are unwilling to engage in extensive advertising and promotion of a product if the final sales may be made by another distributor."  As a result, it said, the "closed territories made for the vigor and health of Sandura, increasing the competitive good that flows from interbrand competition, without any showing of detriment to intrabrand competition."  Thus, the court said, the Commission's finding that the practice was "without justification or redeeming virtue," was "without support in the evidence."  In his 1966 article, Bork instanced Sandura as the lower court decision that "came nearer to the mark" at understanding the rationale of such restraints than other lower courts that had also rejected per se condemnation.  See Bork, Rule of Reason and the Per Se Concept, 75 Yale L. J. at  433.

7.   A neutral observer in 1967 may have reasonably predicted that the Supreme Court would soon expressly adopt the reasoning of Sandura and hold that non-price intrabrand restraints were subject to rule of reason scrutiny.  But then came Schwinn.  The government claimed that Schwinn had imposed exclusive territories on its wholesalers and also prevented retailers from reselling Schwinn's products to unapproved dealers.  The trial court found that exclusive territories at least were unlawful per se with respect to those products to which Schwinn no longer retained title.  By contrast, when Schwinn did retain title, as with a consignment agreement, such restraints survived per se condemnation and were instead analyzed under the Rule of Reason.  After conducting such an analysis, the court held that the United States had failed to prove that Schwinn's consignment agreements were unreasonable.

      The United States appealed, hoping to overturn the trial court's determination that the consignment restraints were not unreasonable.  Schwinn did not cross-appeal, thereby leaving in place the district court's per se condemnation of exclusive territories governing the disposition of products after title had passed.  Two antitrust all stars helped draft the government's brief: Donald Turner, a Yale-educated economist on leave from Harvard Law School and leading the Antitrust Division, and Richard Posner, a recent Harvard Law School graduate in the Solicitor General's office.  The brief claimed that the restrictions were unreasonable because they limited price competition between wholesalers and retailers without producing any offsetting benefits.  To bolster the claim that no benefits were present, the brief contended that: "integration into distribution may sometimes benefit the economy by leading to cost savings, agreements to retail prices or impose territorial restrictions of limited duration or outlet limitations of the type involved here have never been shown to produce comparable economies." (p. 50).

 8.  It should be noted that the opinion of the Antitrust Division of the Department of Justice was not unanimous.  Instead, Oliver Williamson, a young economist serving as a special assistant to Donald Turner, objected to the Turner/Posner position.  In 1999, Williamson conceded that, despite his objection, he did not have an alternative theory that explained such restraints.  See Oliver E. Williamson, Some Reflections, in Firms, Markets and Hierarchies, 32, 32  (Glenn R. Carrol and David E. Teece, Editors) (1999).  It thus does not seem that Williamson invoked the reasoning of Bork's very recent article on the subject. Unfortunately Turner and Posner persisted despite Williamson's objection.

9.  Schwinn's own brief asserted that it adopted its system so as to "encourage local sales effort by small retailers, including local advertising, salemanship and all forms of promotional advertising, as a competitive weapon against the heavy competitive advertising of large, well-financed mass merchandisers (i.e., Sears, Wards, etc.)."   (p. 94).   It did not, however, contend that dealers would refuse to promote Schwinn's products without exclusivity.    Schwinn mentioned Sandura once in its 114 page brief, and then only as part of a long string cite of decisions that had declined to condemn non-price restraints as unlawful per se.

10.  In a lengthy and sometimes confusing opinion, the Court abandoned White Motors and implicitly rejected the logic of Sandura.  Even though Schwinn had conceded the issue, the Court reached out to opine that exclusive territories are unlawful per se.  The Court did not mention the Northern Pacific Railway test for per se illegality or the concept of redeeming virtues.  Nor did it take issue or even allude to arguments made in White Motor and Sandura that such restraints could encourage dealers to expend sufficient resources on promotion.  Instead, the Court's brief analysis of the question invoked Dr. Miles v. John D. Park & Sons, 220 U.S. 373 (1911), which had banned minimum resale price maintenance.  Exclusive territories and other limits on resale, the Court said, were analogous to minimum rpm and should suffer the same fate.  See Schwinn, 388 U.S. at 378.

11.  It may be difficult to fault the Schwinn Court for failing to recognize and incorporate Bork's analysis.  At the same time, decisions such as Sandura pointed in the right direction.  Moreover, the Court would subsequently expressly ignore Bork's analysis in United States v. Topco, 405 U.S. 596 (1972).

12.  Nonetheless, Schwinn still prevailed.  After a lengthy exegesis, the Court finally turned to the question actually before it, viz., whether the intrabrand restrictions obtained via consignment agreements were unreasonable.  In three paragraphs, the Court affirmed the district court's holding rejecting the government's rule of reason case.  See Schwinn, 388 U.S. at 380-82.  Among other things, the Court noted that Schwinn's market share was declining in the face of stiff competition, including from mass merchandisers, the agreements allowed dealers to carry competing brands of bicycles, and consumers had access to bicycles sold to numerous competitors.  At the same time, the Court's analysis left the reader wondering how, exactly, the restraints themselves helped bolster Schwinn's competitive position vis a vis rivals.

13.  The Schwinn opinion sowed the seeds for future critiques.  For instance, the Court did not articulate the methodology it employed to determine whether restraints are unlawful per se.  Nor did the Court explain why that (unexplained) methodology treated the passage of title as dispositive.  Finally, the Court's rule of reason analysis rested in part on an assumption that furthering interbrand competition is a redeeming virtue, thus raising the possibility that other restraints that might produce such benefits would thereby avoid per se condemnation.

Stay tuned for "the rest of the story."

O'Bannon, the Rule of Reason, and the Less Restrictive Alternative Test

Applied Reason to College Athletics

Earlier this year, in O'Bannon et al. v. NCAA, the U.S. District Court for the Northern District of California invalidated the NCAA's policy governing compensation that colleges and universities may provide football and basketball players. (Here is a link to the decision.)  That policy allowed schools to provide players a full grant-in-aid, namely, full tuition, fees, room and board, and the cost of textbooks.  Moreover, the policy also allows schools to provide additional compensation to the neediest student athletes --- those who qualify for federal Pell grants.   

Ordinarily, agreements between rivals regarding the compensation paid to input suppliers are unlawful per se.  Ditto for agreements that govern non-price aspects of the relationship between rivals and input suppliers.  If Ford, Toyota, Honda and General Motors agreed on the salaries or working conditions provided their engineers, for instance, courts would rightly declare the arrangement a buyers' cartel and condemn it as unlawful per se under the Sherman Act.  Ditto if, say, several silicon valley firms or an academic trade association agreed not to hire or "poach" individuals employed by rivals. 

In NCAA v. Board of Regents of the University of Oklahoma, 468 U.S. 85 (1984), the Supreme Court rejected the analogy between the NCAA's policy on player compensation and the sort of buyers' cartel just described.  As explained in much greater detail here, the Court, in an opinion by Justice John Paul Stevens (pictured above), recognized that, unlike buyer cartels, the NCAA is a legitimate joint venture, the existence of which is necessary to produce a product, college football, that many consumers find attractive.  The Court also recognized that unbridled rivalry between colleges and universities for student-athletes would transform college athletics into semi-pro athletics, thereby undermining consumer demand for the joint venture product.  Thus, the Court expressly noted that, in order to protect the integrity of this product, members of the NCAA must collectively set limits on player compensation.  In so doing, the Court rejected the "cartel" label for such restraints.  (For additional discussion of the NCAA decision by this blogger, go here.) According to the Court:

"The identification of this 'product' with an academic tradition differentiates college football from and makes it more popular than professional sports to which it might otherwise be comparable such as, for example, minor league baseball.  In order to preserve the character and quality of the 'product,' athletes must not be paid, must be required to attend class, and the like.  And the integrity of the 'product' cannot be preserved except by mutual agreement: if an institution adopted such restrictions unilaterally, its effectiveness as a competitor on the field of play might soon be destroyed.  Thus, the NCAA plays a vital role in enabling college football to preserve its character, and as result enables a product to be marketed which might otherwise be unavailable.  In performing this role, its actions widen consumer choice --- not only the choices available to sports fans but also those available to athletes -- and hence can be viewed as procompetitive."

See NCAA, 468 U.S. at 101-102 (emphasis supplied).  

More technically, the Court essentially held that unbridled competition between NCAA member schools to attract and retain student athletes would result in a market failure and reduce economic welfare, including the welfare of consumers.  Such rivalry, one suspects, could result in six figure salaries for some players at some schools, over and above a full grant-in-aid.  The prospect of such a market failure, the Court believed, distinguished the NCAA's limits on player compensation from otherwise analogous forms of collective wage setting such as the hypothetical agreements between automobile manufacturers mentioned above.  (See this essay by this blogger explaining the role of the market failure paradigm in the antitrust jurisprudence of Justice Stevens, including his opinion in NCAA.) 

The NCAA court did not hold that agreements governing student-athlete compensation are lawful per se.  Instead, such agreements are to be analyzed under Standard Oil's Rule of Reason. After conducting this analysis, the district court in O'Bannon agreed with the NCAA (and the Supreme Court) that the NCAA's limits on student-athlete compensation produce significant procompetitive benefits by, for instance, enhancing consumer demand for college football and basketball.  These benefits, the court apparently assumed, would suffice to justify the restraints.   Nonetheless, the court invalidated the limits, holding that a "less restrictive alternative" would achieve the same benefits.  In particular, the court held that increasing the limit to "cost of attendance" (which includes grant-in-aid plus transportation and supplies), plus $5,000 per year, to be derived from "licensing revenue generated from the use of their names, images, and likenesses during college[,]" would be "less restrictive of competition, while at the same time achieving the same admitted benefits as the current policy.

This blogger has joined a brief amicus curiae by fifteen antitrust scholars taking issue with the district court's application of the less restrictive alternative test.  (Here is a link to the brief.  See here for a story about the brief on CBSSPORTS.com ) The brief does not question the role that a properly-applied less restrictive alternative analysis can play in rule of reason analysis.  At the same time, the brief contends that the district court misapplied this test.

Ordinarily the less restrictive alternative test involves identification of a different type of agreement, actually existing somewhere in the marketplace, that produces the same benefits as the agreement under scrutiny.  Thus, in the context of product distribution, courts evaluating vertically-imposed exclusive territories could conceivably conclude that so-called "location clauses" are less restrictive of competition and produce the same benefits in a particular setting as exclusive territories.  Cf. Continental T.V. v. GTE Sylvania, 433 U.S. 36 (1977) (describing location clause and holding that courts should evaluate such restraints under the rule of reason).  However, the O'Bannon court did not identify any such categorically different alternative actually existing in the marketplace.  Instead,  the court simply amended somewhat (upward) the level of compensation that players can potentially receive, without questioning the need for a collectively-set limit on such compensation.

Not surprisingly, then, the brief argues that the district court improperly treated the less restrictive alternative test as a license to substitute its own judgement about appropriate compensation for the judgment of market participants who adopted policies that, according to the court's own findings, produced significant economic benefits. Thus, the district court's approach empowers judges to function as regulatory commissions, recalibrating otherwise reasonable levels of compensation.  Such quasi-regulators would displace beneficial agreements that produce significant economic benefits, simply because the judge believes that a hypothetical variant of the agreement, in this case one involving somewhat higher compensation for some players, would produce marginally greater net benefits than the agreement the parties actually adopted.  However, as Judge Frank Easterbrook --- who argued NCAA for the defendants -- once explained when applying the rule of reason in a subsequent case: "the antitrust laws do not deputize district judges as one-man regulatory agencies."   See Chicago Professional Sports Ltd. Partnership and WGN v. National Basketball Association, 95 F.3d 593, 597 (7th Cir. 1996).  Instead, courts must simply ask whether a restraint is "reasonably necessary" to produce the benefits in question.   Hopefully the Ninth Circuit will agree with Judge Easterbrook and properly apply the rule of reason that has, thanks to NCAA and Justice Stevens, been applicable to such restraints for the past three decades.

Update:

Yesterday the U.S. Supreme Court granted certiorari in NCAA v. Alston, No. 20-512.  (See the SCOTUSblog entry for the case here.)  In Alston, the Ninth Circuit invalidated the NCAA's restrictions on the education-related benefits member institutions may offer student-athletes.  The petition seeking such review contends that O'Bannon "disrupted the judicial consensus" reached in other federal courts regarding how to assess restraints adopted by sports leagues, both amateur and professional.  (See petition at 11).  The petition also contends that, in Alston, the Ninth Circuit went "far beyond O'Bannon," by holding that "virtually all NCAA rules limiting so-called 'education-related benefits' are invalid." (See petition at 4).  The Supreme Court has not yet set the schedule for briefing and oral argument, but we can expect a decision by the end of this Supreme Court term, namely, early July, 2021.  Resolution of this controversy will require the Court to revisit its previous statements, convincing to this blogger, that unbridled rivalry between NCAA members for the recruitment and retention of student athletes would result in a market failure that undermines the integrity of the product that this joint venture offers to consumers.  The prospect of such a market failure, of course, would save such restraints from per se condemnation, because of the possibility that such restraints will produce redeeming virtues.  If the Court does reiterate this conclusion, it will presumably move on to provide additional guidance regarding how to conduct a fact-intensive assessment of such restraints under the Sherman Act's Rule of Reason.

 

William Howard Taft's Prescient Endorsement of Standard Oil, 112 Years Young

Knew Something About The Sherman Act

A previous post on this blog celebrated the birthday of Standard Oil Co. v. United States, 221 U.S. 1 (1911).  As explained in that post, Standard Oil articulated the "Rule of Reason" that courts apply when determining whether an agreement between two or more firms is a "contract, combination or conspiracy in restraint of trade or commerce among the several states" and thus contrary to Section 1 of the Sherman Act.  Recognizing that all agreements restrain trade in some sense, the Standard Oil Court read Section 1 narrowly, so as not to offend liberty of contract.  Thus, the Court held that Section 1 bans only those restraints that produce "the consequences of monopoly," namely, prices above the competitive level, output below the competitive level, and/or quality below the competitive level. 

Standard Oil was controversial at the time, with Justice Harlan (in dissent) and various commentators claiming that the Court's Rule of Reason contravened two key Supreme Court precedents, including United States v. Joint Traffic Association, 171 U.S. 505 (1898), and United States v. Trans Missouri Freight Association, 166 U.S. 290 (1897).   Harlan and others also invoked Addyston Pipe and Steel Co. v. United States, 85 F. 271 (6th Cir. 1898), which the Supreme Court unanimously affirmed.  See 175 U.S. 211 (1899).  According to Harlan, for instance, the Sixth Circuit's Addyston Pipe decision had read Section 1, as interpreted by Trans-Missouri Freight, to ban every contract that restrained trade, without regard to reasonableness.  Harlan issued a similar dissent in American Tobacco v. United States, 221 U.S. 106, 180 (1911), which reiterated Standard Oil's Rule of Reason when interpreting and applying Section 2 of the Sherman Act.

 

Whether he knew it or not, Harlan's charge was potentially embarrassing for then-President William Howard Taft, who, as an appellate judge, had authored the Sixth Circuit's decision in Addyston Pipe and appointed Edmund White, then an Associate Justice, as Chief Justice upon the death of Melvin Fuller. 

 

112 years ago today, President Taft responded to this critique of Standard Oil, without mentioning Harlan by name, in his Third Annual message to Congress.  Some of Taft's remarks, found here on the website of the University of Virginia's Miller Center, are worth re-reading:

 

"In two early cases, where the statute was invoked to enjoin a transportation rate agreement between interstate railroad companies, it was held that it was no defense to show that the agreement as to rates complained of was reasonable at common law, because it was said that the statute was directed against all contracts and combinations in restraint of trade whether reasonable at common law or not. It was plain from the record, however, that the contracts complained of in those cases would not have been deemed reasonable at common law. In subsequent cases the court said that the statute should be given a reasonable construction and refused to include within its inhibition, certain contractual restraints of trade which it denominated as incidental or as indirect.

These cases of restraint of trade that the court excepted from the operation of the statute were instances which, at common law, would have been called reasonable. In the Standard Oil and Tobacco cases, therefore, the court merely adopted the tests of the common law, and in defining exceptions to the literal application of the statute, only substituted for the test of being incidental or indirect, that of being reasonable, and this, without varying in the slightest the actual scope and effect of the statute. In other words, all the cases under the statute which have now been decided would have been decided the same way if the court had originally accepted in its construction the rule at common law.

It has been said that the court, by introducing into the construction of the statute common-law distinctions, has emasculated it. This is obviously untrue. By its judgment every contract and combination in restraint of interstate trade made with the purpose or necessary effect of controlling prices by stifling competition, or of establishing in whole or in part a monopoly of such trade, is condemned by the statute. The most extreme critics can not instance a case that ought to be condemned under the statute which is not brought within its terms as thus construed.

The suggestion is also made that the Supreme Court by its decision in the last two cases has committed to the court the undefined and unlimited discretion to determine whether a case of restraint of trade is within the terms of the statute. This is wholly untrue. A reasonable restraint of trade at common law is well understood and is clearly defined. It does not rest in the discretion of the court. It must be limited to accomplish the purpose of a lawful main contract to which, in order that it shall be enforceable at all, it must be incidental. If it exceed the needs of that contract, it is void.

The test of reasonableness was never applied by the court at common law to contracts or combinations or conspiracies in restraint of trade whose purpose was or whose necessary effect would be to stifle competition, to control prices, or establish monopolies. The courts never assumed power to say that such contracts or combinations or conspiracies might be lawful if the parties to them were only moderate in the use of the power thus secured and did not exact from the public too great and exorbitant prices. It is true that many theorists, and others engaged in business violating the statute, have hoped that some such line could be drawn by courts; but no court of authority has ever attempted it. Certainly there is nothing in the decisions of the latest two cases from which such a dangerous theory of judicial discretion in enforcing this statute can derive the slightest sanction."

 

In short, Taft rejected claims that Chief Justice White's Standard Oil opinion departed from Supreme Court precedent and his own Addyston Pipe decision.   As Taft noted, subsequent decisions had imposed upon Section 1 a "reasonable construction," holding that the statute did not reach incidental or indirect restraints.   See United States v. Joint Traffic Association, 171 U.S. 505 (1898) and Hopkins v. United States, 171 U.S. 578 (1898).   In so doing, the Court avoided claims that the statute was so broad as to offend liberty of contract.  (See here).   Standard Oil, Taft said, simply employed a different verbal formulation, "The Rule of Reason," to describe the very same standard that courts, including Addyston Pipe, had been applying since the late 1890s.  If anything, Taft actually understated his case.  After all, decisions such as Joint Traffic and Hopkins had announced that indirect restraints, including mergers and the formation of partnerships, were beyond the scope of the Sherman Act altogether, regardless of their impact upon prices or output.  Standard Oil, by contrast, contemplated that at least some such transactions could be unreasonable, ironically expanding the scope of the Act to condemn welfare-reducing conduct previously beyond its reach. (See pp. 796-97 of this source).  Moreover, the decision suggested that some agreements were automatically unreasonable, if the "nature and character" of such conduct established that they necessarily produced the consequences of monopoly.  The resulting rule, then replicated, in substance, but not in form, the distinction between "naked" and "ancillary" restraints announced by then-judge Taft in Addyston Pipe.   Like the Rule of Reason itself, this distinction has stood the test of time.

How to Monitor Apple's Monitor

Suspicious of Monitors

 

Section 1 of the Sherman Act forbids "contracts in restraint of trade or commerce among the several states," while Section 2 forbids  "monopolization" and "attempts to monopolize."  The Act also requires the Department of Justice to enforce the Act, by seeking, where applicable, equitable and legal relief in U.S. District Courts against firms and individuals who have violated the Act's provisions.  It appears that the Department may have used this authority to impose, no doubt inadvertently, the very type of monopoly pricing the Sherman Act was designed to prevent.

This last July the United States prevailed in a civil suit that challenged Apple's alleged agreements with book publishers to maintain e-book prices above the levels that unbridled competition would produce.  Among other forms of relief, the United States sought and obtained from the U.S. District Court for the Southern District of New York the appointment of a so-called "External Compliance Monitor," in addition to a new "Internal Compliance Officer," both, of course, at Apple's expense.  The final judgment requiring these appointments did not provide for competitive bidding to set the fees of either monitor but instead simply provided that the monitors would charge a "reasonable" fee. 

In paper's filed the day before Thanksgiving, Apple informed the court that the External Monitor, charged with ensuring that Apple comply with the antitrust laws, is himself charging Apple $1,100 per hour, as well as an "administrative fee" of fifteen percent, for a total of $1265 per hour.  Apple claims that it has never paid such high legal fees.  (See here for a more detailed summary of Apple's objections.)

If Apple's assertions are correct, the government's insistence on such a monitor on the terms described above is supremely ironic.   After all, as explained in previous posts (see  here and here), the whole point of the Sherman Act and its Rule of Reason as articulated in Standard Oil v. United States, 221 U.S. 1 (1911) is to prevent contracts (Section 1) or other practices (Section 2) that produce or maintain monopoly or the consequences of monopoly, without any offsetting efficiency benefits.  These consequences, of course, include prices above those that a competitive market would produce.  By winning the appointment of an External Monitor, against Apple's will and without competitive bidding, the Department of Justice has created conditions conducive to the very sort of competitive harm the Sherman Act was designed to prevent.  To be sure, the monitor's fees cannot themselves violate the Sherman Act, which only regulates "trade or commerce among the several states."  Like the Commerce Clause itself, the Act assumes the existence of pre-existing commerce  that parties might restrain. (See also here and here).  The District Court's coercive (but apparently legal) requirement that Apple purchase legal services against its will does not seem to qualify as such commerce.  Moreover, the terms of the final judgment would authorize Apple to seek a judicial determination that the External Monitor's fee is unreasonable.    However, as William Howard Taft explained long ago in his most famous judicial decision, see Addyston Pipe and Steel Co. v. United States, 85 F. 271 (6th Cir. 1898) (Taft, J.),  judicial oversight of pricing decisions is a poor substitute for the determination of such prices by a competitive market, there competitive bidding by pipe producers.  Judges who take on this task, Taft said, "set sail on a sea of doubt," and rely upon their own "vague and varying opinions" regarding "how much, based on principles of political economy, men ought to be allowed to restrain competition."  See id. at 282-84.  See also National Society of Professional Engineers v. United States, 435 U.S. 679, 692-94 (1978) (describing competitive harm resulting from horizontal agreement not to engage in competitive bidding).

This Blogger has no doubt that the court-appointed External Monitor is a superb attorney who is highly-qualified to perform the duties described in the final judgment.  Moreover, there is no indication that, in setting his fee, the External Monitor has acted in anything other than complete good faith.   Nonetheless, as the Roman poet Juvenal (pictured above) asked, admittedly in a different context, "sed quis custodient ipsos custodes," viz. "who will monitor the monitors themselves?"  The best such monitor, as William Howard Taft explained, is competition.     

Kansas Gets it Right on Minimum RPM

 

Embracing Economic Science

 

Kansas Governor Sam Brownback  recently signed legislation reforming the state's approach to minimum resale price maintenance ("minimum rpm"), thereby conforming the law to the dictates of modern economic science.  (The legislation appears here. An official summary appears here.)  The legislation in question amended the state's Restraint of Trade Act to make it clear that the Act only forbids unreasonable restraints of trade, thereby incorporating into Kansas law the sort of "Rule of Reason" that the U.S. Supreme Court read into Section 1 of the federal Sherman Act in Standard Oil v. United States, 221 U.S. 1 (1911). In so doing, the new statute nullfied the Kansas Supreme Court's recent decision in O'brien v. Leegin Creative Leather Products, 277 P.3d 1062 (Kansas 2012), which had held that the state's Restraint of Trade Act bans any and all minimum rpm agreements, regardless whether the contract is reasonable in a particular case.     

 

The O'brien decision would have made perfect sense as a matter of antitrust policy in, say, 1950.  At that time economists and others were hostile to so-called "non-standard contracts," that is, agreements that limited the autonomy of dealers and others who purchased and took title to a manufacturer's product.  This hostility followed naturally from the state of economic learning at the time. For, as previously explained on this blog, during this era economists and others believed that complete or partial vertical integration could serve only two purposes: first, the realization of technological efficiencies and second, the creation or exercise of market power, by depriving rivals of sources of inputs or otherwise stifling competition.  Because minimum rpm and other non-standard agreements reached across the boundaries of one firm to dictate decisions by other firms, sometimes in other states, such agreements could not produce technological efficiencies.  As a result, economists and others inferred that such agreements, which reduced rivalry, necessarily fortified or exercised market power to the detriment of society's consumers.  The result was the so-called "inhospitality tradition" of antitrust law.  (See pp. 68-80  of this article for a more detailed explanation of the origins of the inhospitality tradition.) 

In 1960, however, everything changed.  In a path-breaking article, Professor Lester Telser explained how minimum rpm could prevent a manufacturer's dealers from free-riding on each others' promotional expenditures, thereby overcoming the market failure that would result if each dealer was left to his or her own discretion when determining promotional tactics. See Lester G. Telser, Why Should Manufacturers Want Fair Trade?, 3 J. L. & Econ. 86 (1960).  Six years later, and as previously recounted on this blog, Robert Bork reiterated Telser's argument and extended Telser's reasoning to non-price vertical restraints such as market division as well as horizontal price and non-price restraints that are ancillary to otherwise legitimate joint ventures. See Robert H. Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division, part II, 75 Yale L. J. 373 (1966).  (See also here,  here, and here for this blogger's views on the appropriate characterization and treatment of such restraints)   

The Supreme Court eventually took these lessons to heart.  Thus, in 1977, the Court, citing Bork and others, overruled a prior decision that had banned non-price vertical restraints such as exclusive territories.   See Continental T.V. v. GTE Sylvania, 433 U.S. 36 (1977).  Two decades later, the Court, again citing Bork and others, overruled a previous decision condemning maximum rpm as unlawful per se. See State Oil v. Khan, 522 U.S. 3 (1997).  Finally, in Leegin Creative Leather Products v. PSKS, 551 U.S. (2007), the Court overruled Dr. Miles v. John D. Park & Sons, 220 U.S.373 (1911), which had banned minimum rpm outright.  Writing for the Court, Justice Kennedy persuasively explained that Dr. Miles was based upon an economic misconception, namely, that manufacturer-imposed minimum rpm is economically indistinguishable from a horizontal cartel among the dealers of a manufacturer's product.  Relying upon the work of Bork, Telser and others, Justice Kennedy explained that, instead, manufacturer-imposed minimum rpm often produces significant efficiencies, by, among other things, preventing free-riding and thus ensuring an optimal amount of promotional expenditures, with the result that per se condemnation of the practice is not justified.  In so doing, the Court followed Standard Oil's requirement that courts employ "reason" to adjust antitrust doctrine in light of "more accurate economic conceptions," that is, advances in economic science.

Of course, the Supreme Court's Leegin decision only governed the federal Sherman Act, which generally does not preempt more interventionist state antitrust regulation, no matter how ill-advised.  Thus, Leegin left states perfectly free to ban minimum rpm as unlawful per se under their own antitrust laws, as some have, thereby reducing the welfare of a state's consumers.  Perhaps Kansas law left the O'brien court with little choice but to reaffirm such a per se ban in 2012.  Be that as it may, the people of Kansas are fortunate to have a legislature apparently committed to conforming the state's antitrust law to the dictates of economic science.

The AALS Cartel

 Not Good Enough for the AALS?

Received Substandard Legal Education?

Over at Truth on the Market, Thom Lambert has taken issue with a rule, promulgated by the American Association of Law Schools, that forbids law schools from making lateral offers of employment to faculty at other schools after March 1.  To be more precise, the rule admonishes against such offers in cases in which the poached faculty member must begin teaching at the new institution that same fall.  Lambert asserts, and I know of no evidence to the contrary, that law schools fastidiously adhere to the rule, even though it is framed as a "best practice."

As Lambert points out, the rule in question is a horizontal restraint of trade between rivals of the sort that courts ordinarily condemn.  Indeed, he expressly (and properly) invokes the Department of Justice's recent suit against eBay, challenging an alleged agreement between eBay and Intuit whereby the two firms agreed not to poach each other's employees.  (The Department also entered a consent decree with Intuit forbidding the practice.)  If the eBay/Intuit agreement violates Section 1 of the Sherman Act, and Lambert makes a persuasive case that it does, then so does the agreement between the member law schools of the AALS.  Such agreements, by their nature, reduce rivalry between companies (in the case of eBay/Intuit) and member schools (in the class of the AALS rule).  At the same time, neither agreement appears to produce any "redeeming virtue" of the sort recognized as cognizable by case law applying the Sherman Act.  To be sure, the fact that a faculty member leaves her institution in, say, May, for another school, can impose substantial costs on the institution that loses the faculty member.   However, as Lambert notes, the costs will vary depending upon the faculty member, the courses she taught, and whether the school is located near other schools that might be sources of potential visitors who would not have to relocate.  As Lambert also points out, schools can protect themselves unilaterally against such harm by entering contracts forbidding their faculty from accepting offers after a certain date, contracts that contain liquidated damages clauses that compensate the school for the any damages suffered when the faculty member leaves late in the year.    (These damages could, for instance, compensate the school for the cost of hiring a visitor to cover the departing faculty member's courses on short notice.)  (By analogy, it should be noted that many universities unilaterally provide that a faculty member who receives a sabbatical must return to teach for at least one year before leaving for another school.)  As a result, Lambert contends, no agreement between law schools is necessary to combat the harms from late departures.

Of course, and as Lambert recognizes, the Sherman Act does not ban all horizontal restraints.  Instead, as previously noted on this blog, courts will allow those horizontal agreements that are necessary to overcome any market failures that would result from parties' reliance upon an unfettered, atomistic market to conduct economic activity.  A classic example is the formation of a partnership and restraints ancillary thereto.  Such restraints may, for instance, prevent individual partners from "moonlighting," that is, competing with the partnership, thereby eliminating horizontal rivalry that would otherwise occur.  Nonetheless, as William Howard Taft explained over a century ago, the common law encouraged such restraints, and properly so.   After all, Taft said, such agreements encourage partners to devote all of their efforts to furthering the business of the partnership, instead of diverting value from the enterprise to themselves or, as modern economists would put it, "free riding" on the larger partership.  See United States v. Addyston Pipe & Steel Co., 85 F. 271, 280 (6th Cir. 1898) (treating such restrictions as paradigmatic ancillary restraints that the law should "encourage"); Robert Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division, 75 Yale L.J. 373, 381-83 (1965) (explaining how such restrictions could prevent free riding by partners on the overall enterprise and thus enhance welfare).  Put another way, such agreements pass muster under the Sherman Act's "Rule of Reason," articulated in Standard Oil v. United States, because they do not restrain trade "unduly," but instead "advance" or "fructify" it. 

In short, horizontal cooperation between rivals is perfectly proper when reliance on the unfettered market would otherwise  result in a market failure and a misallocation of resources.  See Alan J. Meese, Price Theory, Competition and the Rule of Reason, 2003 Ill. L. Rev. 77.  Where, on the other hand, there is no such failure, that is, where unilateral decisions in an efficient market will produce efficient results, there is no rationale for such collective action, and courts should ban otherwise lawful restraints.   See Alan J. Meese, Monopoly Bundling in Cyberspace: How Many Products Does Microsoft Sell?, 44 Antitrust Bulletin 65 (1999).  As the Supreme Court explained in National Society of Professional Engineers v. United States, 435 U.S. 679 (1978), the antitrust laws rest on the assumption that consumers understand their own interests and can assess the virtues and relative prices of competing products.

At the same time, the "anti-poaching agreement" that Lambert has condemned may be the tip of the AALS cartel iceberg.   Even a brief perusal of the organization's membership requirements reveals various provisions that eliminate competition without any apparent market failure justification.  For instance, the AALS provides that law schools must have a full time faculty of a certain minimum size, so as to "provide ready professional relationships among the faculty and between the faculty and the students and to offer a reasonably broad curriculum."  The Nation's first law school, at William and Mary, would have flunked this standard, because the faculty consisted of Founding Father George Wythe, who taught, among others, John Marshall, who would later become Chief Justice of the United States.  So far as I know, however, no one would plausibly argue that Marshall's legal education was "not up to snuff."

The same AALS standards also prevent a law school from de-emphasizing research so as to encourage more teaching,   The standards also mandate that each member school "shall seek to have a faculty, staff, and student body which are diverse with respect to race, color, and sex."  Finally, the standards require each school to have a library of a particular size.  The requirements of minimum faculty size, significant support for research and minimum library size, it should be noted, likely raise barriers to entry, by requiring a new school to enter at a particular scale to become a member.

Each of these standards seems inconsistent with the principle that Lambert espouses and, for that matter, the Supreme Court's antitrust case law.  One can stipulate that large faculties, significant research, diversity and large libraries are "good things" without thereby providing a justification of collective imposition of these objectives.  Put another way, there is no apparent market failure that prevents competition between member schools from resulting in appropriate attention to each of these attributes.  For instance, there is no apparent reason that potential law students are incapable of assessing the value that a diverse faculty will add to their education and thus preferring, other things being equal, those schools with diverse faculties.  That's the way competition in a free society is supposed to work.  Ditto for faculty size.  If a school believes that its large faculty provides a better educational environment, other things being equal, than a smaller faculty and vice versa, each such school should be free to offer its product in the marketplace, subject to market competition from other products.  Who knows, one such school might educate the next John Marshall!
 

No Lobster Cartel in Maine . . . .

Excess Capacity

Not Evidence of Collusive Output Reduction

Flotilla of Lobster Boats Plying Their Trade in Casco Bay

A recent article in the Portland Press Herald quotes a state official warning Maine's lobstermen not to engage in price fixing or collective tactics designed to restrict the supply of lobsters.   In particular, the Press Herald quoted Marine Resources Commissioner Patrick Keliher as follows:

"We have heard that fishermen are seeking to impose a de facto shutdown of the fishery and coercing others into complying by threatening to cut off their gear," Keliher said in his release. "Any such actions will be met with targeted and swift enforcement."

Mr. Keliher is of course correct that agreements between  to fix prices or reduce output are unlawful, both under Section 1 of the Sherman Act and Maine's parallel antitrust statute.   More precisely, an agreement between lobstermen to set prices or reduce output would be unreasonable per se and thus contrary to the "Rule of Reason" that the Supreme Court articulated in Standard Oil v. United States, 221 U.S. 1 (1911).

At the same time, as the Press Herald article notes, individual lobstermen remain entirely free to refrain from setting new traps and/or harvesting from traps already set.  Moreover, it seems highly unlikely than any conspiracy between lobstermen could in fact result in unreasonably low output or unreasonably high prices.  In particular, several factors suggest that any collective effort to increase prices or reduce output would be doomed to fail.  First, there are over 1,000 lobstermen in Maine; it would be difficult to say the least for such individuals to negotiate and police an anticompetitive agreement.  Second, even if most lobstermen in fact agreed to reduce output and increase prices, those who refused to participate in the agreement could undercut it, by increasing their own output and thereby counter-acting any output reduction by conspirators.  Such a response would be particularly effective if the market was characterized by excess capacity, e.g., unused but servicable equipment like the unused lobster traps, pictured above, located on an island in Casco Bay. Third, ostensible participants in a price or output agreement could cheat, surreptitiously setting more traps than called for by the agreement, for instance.  Fourth, even if all current partipants in the marketplace somehow agreed to reduce output and increase prices, any resulting unreasonable prices would attract new entry, thereby increasing output and driving prices back down.

Those suspcious that price fixing might be afoot might invoke reports of lobstermen simultaneously reducing the number of traps set or harvesting less often from such traps, as Businessweek reported earlier this week.  However, such data are equally consistent with an alternative hypothesis, namely, that market participants are rationally responding individually to low lobster prices.  (The Businessweek article reports that lobstermen are receiving between $2 and $2.50 per pound for theit catch; the Press Herald suggests that the price has been even lower.)  Simply put, as prices fall, the payoff from searching for lobsters falls as well, with the result that individual lobstermen might conclude that the cost of such search outweighs the potential benefits, at least in the short run.  Because similar lobster prices prevail throughout the Maine region, numerous lobstermen might individually decide to "stay home." Taken together these individual and perfectly legal decisions might (incorrectly) appear to be the result of collective action.  Absent additional evidence demonstrating actual collective action, however, the public should be confident that the lobstering trade is a well-functioning competitive market.

  

Is The NCAA an Illegal Cartel?

Greedy Cartelist?

June 6, 2021 Update:

Earlier today I posted on this blog a forthcoming paper entitled: Requiem for a Lightweight: How NCAA Continues to Distort Antitrust Doctrine, 56 Wake Forest L. Rev. _____ (2021) (forthcoming).  (See here).  The paper critiques several aspects of the Supreme Court's decision in NCAA v. Board of Regents of the University of Oklahoma, 468 U.S 84 (1984), including the Court's decision to exempt all restraints imposed by sports leagues from per se condemnation as well as dicta suggesting that courts should subject some restraints that avoid per se condemnation to a "Quick Look" version of Rule of Reason.  The paper also endorses NCAA's dicta to the effect that horizontal restrictions on rivalry for the services of student-athletes can produce redeeming virtues, with the result that such restraints should survive per se condemnation.  The paper calls on the Supreme Court to correct these and other errors in NCAA v. Alston and thus ensure a more coherent jurisprudence under Section 1 of the Sherman Act that better reflects the teachings of modern economic theory.

An Op-Ed in Sunday's New York Times entitled "The College Sports Cartel," Joe Nocera decries the fact that NCAA student athletes cannot receive more than a full scholarship, room and board, and stipend to cover living expenses.   As the author notes, NCAA rules --- the product of an agreement between competing member schools --- forbid schools to pay student-athletes a salary analogous to what, say, a minor league baseball team would pay its players.  (Put another way, NCAA rules require student-athletes to remain amateurs.)  The author characterizes this agreement as "collusion" of the sort ordinarily forbidden by the antitrust laws, collusion that enriches member schools at the expense of purportedly "shackled" student athletes.   He ends by opining that "[I]t certainly would be worthwhile to see someone challenge [the NCAA's] cartel behavior in court."

And yet, as Nocera himself perceptively admits: "Sports leagues can’t exist without at least some [so-called] collusion."   A classic example, of course, the agreement between a league's members on the number of games in a season.  Thus, the NBA's decision that each team will play "only" 82 games in the regular season is a horizontal agreement on the output of games, a limitation that could be unlawful in other circumstances.  Ditto for members' agreement on the length of the playoffs, including how many games are in the finals.  (Imagine if Ford, GM and Chrysler announced they were agreeing on the number of pickup trucks they would produce in the coming year.)  Indeed, calling such agreements between members of the NBA "collusion" would deprive the word of any useful descriptive value in this context, as the term would become a synonym of "contract" or "cooperation."

Sports leagues are not unique in this sense.  All sorts of welfare-increasing economic activity is the result of agreements between rivals, agreements that economists and antitrust courts call "horizontal."  For instance, the formation of a partnership is a horizontal agreement that eliminates rivalry between the new partners.  Such partnerships often include explicit agreements between the partners not to "moonlight" and thus compete with the partnership.    Ditto for franchising, which many economists properly conceptualize as an agreement between actual or potential rivals (think of the numerous independent McDonalds franchisees in a medium-sized town).  Such agreements set product standards, decide what products members of the chain will offer, what ingredients each product will contain, etc.  Without such (horizontal) agreements, what consumers currently experience as a well-run franchise system would rapidly devolve into a loose confederation of business establishments that, while operating under the same trademark, would offer varying products and varying degrees of quality, sowing confusion in the mind of consumers and defeating the purpose of operating under a single trademark.  Thus, while such agreements reduce rivalry in some sense between members of a franchise system, they can ultimately enhance the quality of the products offered by a particular franchise system and thus further useful competition with other such systems, to the ultimate benefit of consumers and the rest of society. 

In short, like many productive ventures, the NCAA and other sports leagues entail cooperation between rivals, cooperation that could be problematic in other contexts when viewed in isolation.  The key question from the perspective of the antitrust laws is whether the cooperation in question, while nominally reducing competition between rivals, might in fact overcome a market failure and thus increase the welfare of society by inducing a more efficient allocation of resources.  That, in short, is the focus of antitrust's "Rule of Reason, " announced in Standard Oil v. United States.  (See this article for a more in depth explanation of the connection between market failure and Rule of Reason analysis.)

While litigation against the NCAA on this question might enrich antitrust lawyers, the Supreme Court has already explained how it would rule in such a case.  Twenty-five years ago, in NCAA v. Bd. of Regents of the University of Oklahoma, the Court evaluated NCAA rules limiting the number of games that networks could broadcast on television during any given season.  The rules also limited the number of times that any particular school could appear on television.  The Court condemned the rules under the Rule of Reason because they reduced output without any offsetting benefits.

In so doing, however, the Court expressly approved other horizontal restraints imposed by the NCAA, including those fostering amateurism by the players.  The Court's language (previously discussed on this blog) is worth quoting in full:

"What the NCAA and its member institutions market in this case is competition itself -- contests between competing institutions. . . . . [T]he NCAA seeks to market a particular brand of football -- college football. The identification of this 'product' with an academic tradition differentiates college football from and makes it more popular than professional sports to which it might otherwise be comparable, such as, for example, minor league baseball. In order to preserve the character and quality of the "product," athletes must not be paid, must be required to attend class, and the like. And the integrity of the 'product' cannot be preserved except by mutual agreement; if an institution adopted such restrictions unilaterally, its effectiveness as a competitor on the playing field might soon be destroyed. Thus, the NCAA plays a vital role in enabling college football to preserve its character, and as a result enables a product to be marketed which might otherwise be unavailable. In performing this role, its actions widen consumer choice -- not only the choices available to sports fans but also those available to athletes -- and hence can be viewed as procompetitive."

The Court then noted (as suggested above) that "a restraint in a limited aspect of a market may actually enhance market-wide competition."

Simply put, the Court concluded that unbridled competition between member schools for players, thereby allowing schools to pay players a salary, would result in a market failure.  That is to say, no individual school would, when setting players' compensation, take into account the impact of that decision on the overall "brand" or "image" of the product being offered.  While players might benefit in the short run, the "brand appeal" of college football would suffer over the longer run, as what was once amateur athletics associated with an academic tradition (and thus a natural fan base) would degenerate into a professional league inferior to the NFL and without a natural fan base.

The result may seem to countenance an unfair distribution of the benefits produced by NCAA football.  Certainly some schools earn millions each year due to the performance of their student athletes.  (At the same time, however, many others lose money on the sport, and no one is proposing that student athletes share in these loses.)  However, antitrust law does not exist to ensure a fair division of the gains from economic activity but instead only bans those agreements or unilateral practices that reduce economic welfare. 

Amicus Brief of Antitrust Professors in Hosana Tabor v. Equal Opportunity Commission

This blogger has signed an Amicus Brief in a case pending before the Supreme Court of the United States. The case is Hosana Tabor v. Equal Opportunity Commission, (For a summary of the case, including a link to the various briefs, including amicus briefs, in the case, go here. The opinion in the 6th Circuit that the petitioner is asking the Supreme Court to reverse, can be found here.) Professors Barak Richman of Duke Law School and Harry First of NYU, both leading scholars of antitrust law, co-authored the brief.

The petitioner in the case is a Lutheran church and elementary school that dismissed an employee who taught music and other secular subjects but who also taught daily religion classes, was a commissioned minister and also regularly led her class in prayer. The dismissed teacher claimed that the dismissal violated the Americans with Disabilities Act, and the EEOC intervened in support of the teacher. The 6th Circuit Court of Appeals held that the so-called ministerial exception did not apply, with the result that the plaintiff's suit could go forward on the merits. In particular, the court found it noteworthy that the teacher spent most of her workday teaching secular subjects from secular materials and could not recall bringing religious themes into her secular classes more than twice during her tenure. The court remanded the case to the district court for a determination of whether, in fact, the school had violated the ADA., and the petitioner sought review in the Supreme Court.

The Supreme Court granted certiorari to answer following question:

"Whether the ministerial exception, which prohibits most employment-related lawsuits against religious organizations by employees performing religious functions, applies to a teacher at a religious elementary school who teaches the full secular curriculum, but also teaches daily religion classes, is a commissioned minister, and regularly leads student in prayer and worship."

The amicus brief advises the Court not to expand the scope of the ministerial exception in a way that would provide immunity to professional associations of clergy who engage in concerted action of the sort that produces monopoly or its consequences and is thus unreasonable and unlawful under Section 1 of the Sherman Act. Indeed, at least one professional association of clergy has claimed that horizontal concerted action by the association's members falls within the ministerial exception and is exempt from the Sherman Act. (Professor Richman summarizes the policies of this association, the Rabbinical Assembly, and why they are problematic under the Sherman Act here.) As the brief explains, such concerted action among rivals can reduce competition among clergy for particular positions and also limit the number of clergy whom individual congregations can interview and offer positions, thereby increasing the bargaining leverage of such clergy. Moreover, such conduct does not fall within the contours or rationale of the ministerial exception, which applies in the context of employer-employee relationships between, say, a church or synagogue and its minister or rabbi. Indeed, as the brief explains, limiting the exception to cases involving the employer/employee relationship would not prejudice the petitioner's case at all and would instead protect the ability of other congregations to search for and hire clergy of their choice without interference from unlawful concerted action.

Happy Birthday Standard Oil v. United States, 221 U.S. 1 (1911)

Probably a Better than Average Investment at the Time

Didn't Live to 100, But His Greatest Decision Did

Sunday May 15 was the 100th birthday of Standard Oil v. United States, 221 U.S. 1 (1911). Authored by Chief Justice Edward D. White, pictured above, Standard Oil is the most important antitrust decision ever, having articulated certain fundamental principles that still animate antitrust law. Here are a few examples of Standard Oil's enduring principles, followed by some additional thoughts.

1. Standard Oil confirmed what was at least implicit in several prior decisions, namely, that the Sherman Act does not ban all contracts that "restrain trade" in the ordinary sense of that phrase. Instead, the Court said, the statute only bans agreements that restrain trade "unduly" by producing "monopoly or its consequences." To determine whether a contract produces such consequences, Standard Oil said, courts should employ "reason." Thus was born the Sherman Act's "Rule of Reason." Some, including Justice Harlan in dissent, argued that this Rule of Reason was a departure from prior case law which had purportedly banned all restraints of trade. However, as Chief Justice White explained for the Court, prior decisions had banned only "direct" restraints, leaving so-called "indirect" restraints entirely unscathed. See e.g. United States v. Joint Traffic Ass'n, 171 U.S. 505 (1898). Moreover, White continued, courts had employed "reason" to distinguish "direct" from "indirect" restraints, treating as "direct" only those restraints that produced monopoly or its consequences. Thus, he (properly) concluded, the "direct/indirect" test and the "Rule of Reason" would, if properly applied, would reach identical results. William Howard Taft, then President of the United States, agreed with the Court's assessment of precedent and expressed that agreement in a December 2011 message to Congress.

2. After examining both English and American sources bearing upon the meaning of the term "restraint of trade," the Court identified three possible "consequences of monopoly," the presence of which would require condemnation of a restraint because it restrained trade "unduly," namely output reduction, price increases, and reductions in quality. The mere fact that an agreement restricted the freedom of action of the parties to it did not suffice to render it a "restraint of trade" within the meaning of the statute. Courts still adhere to this principle today, requiring a showing or inference of tangible economic harm before condemning a restraint. For instance, in Continental T.V. v. G.T.E. Sylvania, 433 U.S. 36, 53 n. 21 (1977), the Court pointed out that all contracts restrain trade, and concluded that courts should only consider the objective economic effects of agreements when conducting Rule of Reason analysis. Thus, Standard Oil rejects assertions that courts should consider non-economic values, such as the autonomy of traders, when given content to the Sherman Act.

3. Any broader reading of the statute, e.g., one that applied "its prohibitions to any case within its literal language" would contravene the Constitution's protection for liberty of contract or, in the Court's words "be destructive of all right to contract or agree or combine in any respect whatever as to subjects embraced in interstate trade or commerce." Thus, instead of reading the statute broadly so as to ban each and every agreement that reduced competition in one way or another, the Court held that reasonable restraints of trade were protected by liberty of contract and thus beyond the reach of the statute, even if they otherwise restrained interstate commerce. Protection of such restraints, the Court said, was the best way to ensure a well-functioning competitive order.

"[T]he omission [from the Sherman Act] of any direct prohibition against monopoly in the concrete, indicates a consciousness that the freedom of the individual right to contract, when not unduly or improperly exercised, was the most efficient means for the prevention of monopoly, since the operation of the centrifugal and centripetal forces resulting from the right to freely contract was the means by which monopoly would be inevitably prevented if no extraneous or sovereign power imposed it and no right to make unlawful contracts having a monopolistic tendency were permitted. In other words, that freedom to contract was the essence of freedom from undue restraint on the right to contract."

The Supreme Court reiterated this insight, albeit without mentioning liberty of contract, nearly six decades later, citing Standard Oil for the proposition that Congress could not have meant to ban all private contract law because that body of law "establishes the enforceability of commercial agreements and enables competitive markets -- indeed, a competitive economy -- to function effectively." See National Society of Professional Engineers v. United States, 435 U.S. 679 (1978).

4. As a corollary to the ban on "undue" restraints, Standard Oil's Rule of Reason implied a safe harbor for "normal," "usual," or "ordinary" agreements. Indeed, the Court condemned the Standard Oil trust precisely because its growth, the Court said, was "not as a result of normal methods of industrial development[.]" Or, as the Court put it in the American Tobacco Co. v. United States, 221 U.S. 106 (1911), decided two weeks later: "[Standard Oil held] that the statute did not forbid or restrain the power to make normal and usual contracts to further trade by resorting to all normal methods, whether by agreement or otherwise, to accomplish such purpose." American Tobacco, it should be noted, reaffirmed Standard Oil's promulgation of the Rule of Reason and held that a similar analysis, including the distinction between undue and normal/usual/ordinary restraints, should control courts' determination whether a defendant has "monopolized" interstate commerce contrary to Section 2 of the Sherman Act. Subsequent decisions confirmed that a contract or other practice was "normal" or "ordinary" and thus beyond the scope of Congress's power to regulate under the Sherman Act or Clayton Act if it was the type of practice a firm would adopt without regard to the practice's propensity to obtain or maintain market power. See FTC v. Sinclair Oil, 261 U.S. 463 (1923) (holding that the Clayton Act did not empower the Commission “to interfere with ordinary business methods); FTC v. Gratz, 253 U.S. 421 (1920) (same). Courts still employ this approach under Section 2 of the Sherman Act, refusing to condemn conduct that reduces a firm's costs, even if such conduct should maintain or create a monopoly.

5. Standard Oil and its Rule of Reason require a "common law," dynamic approach to the Sherman Act. By its nature, the decision's "Rule of Reason," with its focus on the consequences produced by a challenged restraint, precludes any reading of the statute that would freeze in place a list of restraints that are prohibited or, for that matter, list of restraints that are not prohibited. Instead, the Court held that the statute provides courts with the flexibility to treat particular restraints differently over time, depending upon judges' assessment of the economic consequences of such restraints. Such assessments can change as economic conditions change or as evolving economic theory sheds new light on the impact of particular restraints, leading courts to "translate" the principles animating the Rule of Reason in light of new information. (See pp. 89-92 of this article for additional articulation of this point.) Thus, the Standard Oil Court expressly noted that restraints or other practices that appear harmful at one point in time can, decades or century later appear beneficial or vice versa, thereby justifying different legal treatment. The Supreme Court has repeatedly endorsed this approach. In 1988, for instance, the Court cited Standard Oil for the proposition that "[t]he Sherman Act adopted the term "restraint of trade" along with its dynamic potential. It invokes the common law itself, and not merely the static content that the common law had assigned to the term in 1890." See Business Electronics Corp. v. Sharp Electronics, 485 U.S. 717 (1988). This "dynamic potential," the Court said, included the ability to overrule previous decisions banning particular restraints when advances in economic theory undermined the economic premises of such earlier decisions. See also Continental T.V. v. G.T.E. Sylvania, 433 U.S. 36 (1977) (discarding per se rule against non-price vertical restraints based upon changed economic understanding of such agreements). This dynamic approach has served antitrust law well, as it has allowed courts the flexibility to adjust legal doctrine in response to changed conditions and insights, thereby minimizing the need for Congress to amend the Sherman Act in response to such changes.

Readers interested in further development of these themes may want to consult pp. 83-92 of this article.

Some additional observations:

First, the Standard Oil opinion was extremely controversial at the time as was the American Tobacco decision. Justice Harlan issued a lengthy and vehement dissent, in which he accused his brethren of judicial activism, ignoring precedent and reaching a result unduly favorable to trusts. Harlan even claimed that the Court's purported activism would undermine the public's faith in a neutral judiciary. Harlan's dissent helped fuel similar criticism by commentators and political partisans off the Court. Many criticized President Taft, who had appointed Chief Justice White, and these criticisms no doubt helped motivate Taft's lengthy message to Congress defending the decision mentioned above. Though highly controversial at the time, the Supreme Court unanimously invoked and applied the Rule of Reason just seven years later in Chicago Bd. of Trade v. United States, 246 U.S. 243 (1918), and the stands to this day.

Second, some criticism of Standard Oil reflected a fear that Chief Justice White's version of the Rule of Reason would empower courts to sustain price fixing agreements that set reasonable prices, contrary to what some saw as the holdings of prior decisions. Indeed, dissenting in United States v. Trans Missouri Freight Association, 166 U.S. 290 (1897) , then Associate Justice White, in an opinion joined by Justices Field, Gray and Shiras, argued that a ban on horizontal agreements setting reasonable prices would violate firms' liberty of contract, an argument the Court rejected, at least in the context of railroad corporations that had received special privileges from states where they operated, in both Trans-Missouri Freight and United States v. Joint Traffic Ass'n, 171 U.S. 505 (1898). (In Addyston Pipe and Steel Co. v. United States, 175 U.S. 211 (1899), by contrast, the Court first sustained the lower court's finding that the cartel set unreasonable prices before (unanimously) holding that the price fixing in question was a direct restraint of interstate commerce in violation of the Sherman Act.) However, Standard Oil does not address one way or the other whether in fact horizontal agreements setting reasonable prices would survive scrutiny under the Rule of Reason. Thus, future decisions condemning such price fixing without regard to the reasonableness of the price set did not contravene Standard Oil. See e.g. United States v. Trenton Potteries, 273 U.S. 392 (1927) (condemning agreement between firms with 80 percent share of the relevant market without regard to reasonableness of the price set).

Third, principles announced in Standard Oil apply equally to Section 1 and Section 2 of the Sherman Act, as the Court confirmed in the American Tobacco mentioned earlier in this post. Section 1, of course, applies to "concerted action," that is, an agreement between two or more parties. Section 2, by contrast, applies only to conduct that is "unilateral." At the same time, the modern Rule of Reason applied under Section 1 differs from that applied under Section 2 in two ways. First, courts analyzing concerted action under Section 1 purportedly "balance" any harms that a restraint produces against any benefits, in an effort to determine which impact predominates. (See pp. 98-113 of this article for a general discussion of this analysis and some of the issues that arise; see also this comprehensive article about how modern courts conduct rule of reason analysis.). By contrast, courts analyzed challenged conduct under Section 2 conduct no such balancing. Thus, in the Section 2 context, proof that challenged conduct produces significant benefits that cannot be achieved in some other way ends the case, without regard to whether such conduct outweighs any purported harms. Second, when balancing harms versus benefits under Section 1, courts purport to ascertain whether the restraint increases or decreases prices paid by consumers, thus implementing a "purchaser welfare standard." Under Section 2, by contrast, courts treat the prices paid by purchasers as beside the point. Thus, if conduct is "normal" or "usual" because it produces benefits independent (See pp. 673-86 and 708-15 of this article for a demonstration that courts implementing Section 2 have never focused on the welfare of purchasers but have instead articulated doctrine that seeks to ban only that conduct that reduces overall economic welfare). At some point, it seems, courts will have to reconcile these contradictions.