On July 31, 2006, a unanimous Federal Trade Commission (“Commission” or “FTC”) ruled that Rambus Inc.’s “acts of deception constituted exclusionary conduct under Section 2 of the Sherman Act, and that Rambus unlawfully monopolized the markets for four technologies” that were incorporated into the Dynamic Random Access Memory (“DRAM”) standards adopted by the Joint Electron Device Engineering Counsel (“JEDEC”) for the Synchronous DRAM (“SDRAM”) and the Double Data Rate SDRAM (“DDR-SDRAM”) in violation of Section 5 of the Federal Trade Commission Act (“FTC Act”).  Liability Op. at 3.[1]  In its Liability Opinion, the Commission found, “Through a course of deceptive conduct, Rambus exploited its participation in JEDEC [an industry-wide standard-setting organization] to obtain patents that would cover technologies incorporated into now-ubiquitous JEDEC memory standards, without revealing its patent position to other JEDEC members.  As a result, Rambus was able to distort the standard-setting process and engage in anticompetitive ‘hold up’ of the computer memory industry.”  Id. at 3.

However, the Commission deferred the remedy issue and sought further briefing from the Complaint Counsel and Rambus on the appropriate remedy.  Id. at 119-120.  In their briefs and at oral argument, both the Complaint Counsel and Rambus agreed that the Commission was authorized to issue cease and desist orders prohibiting “future deceptive conduct by Rambus.”   Remedy Op. at 2.[1]   The parties parted, however, on “whether the Commission may order broader relief, and, if broader relief is authorized, on the scope of an appropriate remedy on the basis of the record before [the Commission].”  Id. at 2. 

In effect, Rambus argued that the Commission has no authority to issue compulsory licensing and set the terms of such licenses.  Id. at 6.  On the other hand, the Complaint Counsel argued that the Commission should “order royalty-free compulsory licenses for Rambus’s pre-1996 patent portfolio for those firms practicing JEDEC’s standards.”  Id. at 8.  The Complaint Counsel argued, “this remedy – ‘far from being extreme – merely restores, six years later, the competitive conditions that should have prevailed’ had Rambus not engaged in deception[,]” and “that imposition of royalty-free compulsory licenses is well within the Commission’s broad discretion to restore competition and to deny Rambus the benefits of its illegal conduct.”  Id. at 8.  The Complaint Counsel contended that “enjoining enforcement of the relevant patents against JEDEC-compliant products [was] appropriate because, absent Rambus’s deception, JEDEC would have selected alternative technologies – including alternatives with inferior performance – in lieu of paying royalties, thus leaving Rambus with no claim to royalties.”  Remedy Op. at 11-12.

The Majority Decision

On February 2, 2007, with two Commissioners partially dissenting, a divided Commission held that, although it had the power to order royalty-free licensing as a remedy when the evidence and circumstances justified it, Remedy Op. at 8-10, such a remedy was not justified in the circumstances of that case, id. at 12-16.  The majority instead set maximum royalties that Rambus could collect going forward on JEDEC-compliant DRAM and non-DRAM products that comply with SDRAM and DDR-SDRAM standards.  Remedy Op. at 27-29; Remedy Order at 2-3.  Furthermore, the majority’s remedy did not reach DDR2-SDRAM standard.

In reaching its conclusion that royalty-free licensing was not warranted, the majority concluded,

We recognize that Rambus’s unlawful conduct makes it difficult to reconstruct the “but for” world, as is typically the case when a party has violated the antitrust laws. We conclude, however, that Complaint Counsel have not satisfied their burden of demonstrating that a royalty-free remedy is necessary to restore the competition that would have existed in the “but for” world– i.e., that absent Rambus’s deception, JEDEC would not have standardized Rambus technologies, thus leaving Rambus with no royalties.

Remedy Op. at 12.  The majority further explained,

We have examined the record for the proof that the courts have found necessary to impose royalty-free licensing, but do not find it. Our liability opinion identified two realistic possibilities for what would have occurred had Rambus not engaged in deception of JEDEC members: either (i) JEDEC would have chosen alternative technologies, or (ii) JEDEC would have incorporated Rambus’s technologies into the standard but would have demanded, as a precondition of adopting Rambus’s technology, that Rambus agree to license the technology on RAND terms. [Footnote] There is evidence in the record to support both possibilities.

Id.

As to the first possibility, the Commission explained, “it is true that if JEDEC had chosen to include other, non-Rambus technologies, its members would have paid no royalties to Rambus. But that does not mean that incorporating those technologies rather than the Rambus technologies would have been costless.”  Id. at 12-13.  Because Rambus’s cost-benefit analysis “was faulty” and “Complaint Counsel did not provide a cost-benefit comparison of the available technologies,” the majority concluded that it did “not know what the costs might have been.”  Id. at 13. 

The Complaint Counsel argued that this “evidentiary gap” could be closed because “Rambus would not have issued the commitment to license on RAND [Reasonable and Non-Discriminatory] terms required by JEDEC and EIA regulations,” pointing “to evidence that show[ed] that Rambus did not want to license technology on RAND terms and that it even made statements that offering RAND terms was contrary to its business model.”  Remedy Op. at 13.  Rejecting this contention, the majority explained, “An unwillingness to comport with JEDEC policy while pursuing a hold-up strategy is not necessarily indicative of how Rambus would have acted after disclosure, when hold up no longer was attainable.”  Id.

As to the second possibility, the Commission acknowledged that “the evidence show[ed], and in the liability opinion the Commission found, that JEDEC was reluctant to incorporate patented technologies.”  Id. at 15.  However, the Commission concluded that, while JEDEC minutes indicated a “reluctance” to adopt patented technologies, those minutes did not “state that the committee will not standardize a patented technology, and the basic JEDEC and EIA documents repeatedly spell out procedures under which patented technologies may be accepted.”  Id. (emphasis in original).  The Commission also identified from the record “several occasions in which JEDEC incorporated patented technologies into some standards after securing agreement from the patent holder that the technologies would be licensed on RAND, or specific-royalty, terms.”  Id. at 15-16.  Finally, the majority also discounted as ambiguous, “albeit sincere,” testimony by several JEDEC members that they would have opposed inclusion of Rambus’s technologies, and opted for alternatives had they been aware of Rambus’s patent position.  Id. at 16. 

At bottom, according to the majority “while there [was] some evidence that support[ed] the possibility that JEDEC would have chosen alternative technologies, Complaint Counsel [had] not met the burden of demonstrating that restoring the competition that would have existed in the ‘but for’ world requires that Rambus license its technology with no compensation.”  Id. at 16.

Commissioner Rosch’s Partial Dissent

While agreeing with the majority’s conclusion that the Commission had the authority to order broad relief beyond forward-looking injunctive relief, including compulsory, royalty-free licensing, Commissioner Rosch disagreed with the majority’s conclusion that above-zero royalties were appropriate under the facts of that case.  Statement of Commissioner J. Thomas Rosch, Concurring in Part and Dissenting in Part ("Rosch Stmt."), at 1.[2] 

Commissioner Rosch also agreed that “there must be ‘special proof’ of the need for” a royalty-free compulsory licensing remedy, and that “Complaint Counsel bears the burden of proving what the ‘but for world’ would have looked like.”  Id. at 2.  However, absent any precedent on the particular quantum of required proof, he noted “that where the relief sought is necessary ‘to eradicate all the consequences of the act, … any plausible doubts should be resolved against the monopolist.” Rosch Stmt. (citing Areeda & Hovenkamp, Antitrust Law ¶653(f), at 104 (2002)). 

Here, he argued, “there is strong evidence in the record that if JEDEC had been aware of the potential scope of Rambus’s patent portfolio, it would have adopted standards that would have avoided Rambus’s patents.”  Id. at 4 (emphasis added).  He explained, “JEDEC’s rules, the expectations of its membership, and the market’s concerns with costs generally and the cost of Rambus’s technologies in particular all strongly support a finding that a fully informed JEDEC would have adopted standards that did not read on Rambus’s patents.”  Id. 

According to Commissioner Rosch, “The record also demonstrate[d] that JEDEC’s membership was particularly concerned with incorporating technologies into JEDEC’s standards that could potentially read on Rambus’s patents,” as demonstrated by, among other things, “the reaction of the marketplace to Rambus’s proprietary DRAM standard – RDRAM.”  Id. at 5.  As an example, he explained, “Rambus failed in its efforts to position RDRAM as the de facto market standard, at least in part, because the DRAM manufacturers’ concerns about cost led them to adopt standards that they believed were not proprietary.”  Id. 

Commissioner Rosch also discounted evidence upon which Rambus and the majority relied that indicated JEDEC’s willingness at times to adopt patented technologies into its standards after it received RAND assurances.  In that regard, he argued,

[I]n all but one instance (Mosaid, whose patents were not essential to the standard), the evidence shows that the holders of those patents were, unlike Rambus, manufacturers, and that JEDEC viewed manufacturers differently from non-manufacturers, believing that the former had incentives to cross-license their technology for de minimis or no royalties. [footnote] Thus, it does not follow that because JEDEC was willing to adopt the technologies of those manufacturer patent holders it would have been willing to do so in Rambus’s case.

Id. at 5-6 (emphasis in original). 

Commissioner Rosch also rejected the majority’s treatment of testimony in the record from JEDEC members indicating that they would have adopted alternatives if they were aware of Rambus’ patent position: 

[I]n the context of mergers the Commission has embraced unimpeached customer testimony as powerful evidence of the “but for world.” [footnote] Where, as here, customer testimony is not only given under oath but is supported by the actions of the customers before the controversy has arisen, and is otherwise unimpeached, there is no reason not to credit it. Although it is also said that the testimony of JEDEC’s members is contrary to their agreement “to incorporate patented technologies into the SSO’s standard in several instances,” that is not supported by the record respecting the actions of JEDEC’s members where Rambus or companies like Rambus that were pure inventors (as contrasted with manufacturers) were involved.

Id. at 6. 

He disagreed that, had Rambus disclosed its patent position, JEDEC may have adopted Rambus’s technologies and would have been able to obtain RAND assurances from Rambus.  He argued, “the record shows that Rambus was strongly opposed to RAND terms because they were contrary to its business model. [Footnote] There is also evidence that on at least two occasions, Rambus made it clear that it would not commit to RAND terms in the standard setting context.”  Rosch Stmt. at 7.  He stated, other than the testimony of Rambus’s expert, “Rambus’s counsel could not cite the testimony of a single percipient witness, nor a single document in the record, to support its position that Rambus would have offered a RAND commitment. [Footnote]”  Id. at 8.

Commissioner Rosch also disagreed that the Complaint Counsel had the burden of coming forth with its own cost-benefit analysis, as the majority seemed to have required.  In this regard, he argued, “Insofar as that is considered to undercut Complaint Counsel’s challenge to Rambus’s position that it would have been compensated for the ‘incremental value’ of its technology in the ‘but for’ world, the contention fundamentally misconceives of the way that a fact is proved at trial.”  Id. at 10.  Failing the presence of any direct evidence here, he explained, the “‘but for world’ must of necessity be proved by circumstantial evidence,” one form of which is after-the-fact cost-benefit analysis, as Rambus attempted to present.  Id.  According to Rosch, “Complaint Counsel were not obligated to submit the same kind of circumstantial evidence,” particularly where they offered other circumstantial evidence: “evidence of the contemporaneous views and actions of JEDEC and its members vis-a-vis patented technologies and of Rambus’s antipathy toward a RAND commitment – in order to prove the ultimate fact regarding what would have happened in the ‘but for world.’”  Id.

Commissioner Rosch concluded, “Ultimately, . . . licensing on terms above zero would enable Rambus to obtain royalties it would not have obtained in the ‘but for world.’ That would enable Rambus to continue to reap the fruits of its ongoing violation of Section 2.”  Id. at 14.  Nonetheless, as with the majority, he also would not have ordered a remedy that would reach the DDR2-SDRAM standard.  Id.

Commissioner Pamela Jones Harbour’s Partial Dissent

As with Commissioner Rosch, Commissioner Harbour also “strongly agree[d] that the Commission’s remedial authority in Section 2 cases extends beyond narrowly constrained cease-and-desist orders and includes the ability to order compulsory, royalty-free licensing.”  Remedy Statement of Commissioner Pamela Jones Harbour, Concurring in Part and Dissenting in Part ("Harbour Stmt."), at 1.[3]  Also along with Commissioner Rosch, she dissented from the majority’s above-zero royalty determination.  Id.  Finally, with one notable exception, she joined Commissioner Rosch’s dissenting statement.  Id.

Unlike Commissioner Rosch, she would have ordered compulsory, royalty-free licensing not only with respect to the SDRAM and DDR-SDRAM standards, but also with regard to the DDR2-SDRAM standard.  Harbour Stmt. at 1.  She explained,

When the Commission fashions a remedy, it should strive to restore, as completely as possible, the competitive environment that would have existed in the “but for” world. [Footnote]  In this case, the Commission can and should impose a remedy that would apply to technologies included in all JEDEC standards that were developed, or in development, at the time Rambus began enforcing its patents. This test would yield a remedy covering DDR2 (but not DDR3 or successive generations). [¶] This formulation would reflect an appropriate use of fencing-in relief – consistent not only with existing jurisprudence regarding the scope of the Commission’s remedial authority, but also with burden-of-proof requirements during the remedy phase.

Id. at 4 (emphasis in original).  She argued that the Commission’s Liability Opinion did not rule out the possibility of DDR2 Lock-in.  Instead, the Commission recognized that it “might have found lock-in with respect to DDR2 SDRAM if the record had demonstrated, for example, that backward compatibility concerns were a substantial determinative factor in JEDEC’s DDR2 SDRAM standard-setting decisions.”  Id. (quoting Liability Op. at 114 n.621).  “For purposes of establishing liability,” she explained, “the record was deemed insufficient to make such a finding.”  Id.

According to Commissioner Harbour, the standard is different for purposes of determining the appropriate remedy, however.  In that phase, “the Commission has three responsibilities: to stop the unlawful conduct; to prevent the unlawful conduct from recurring; and, importantly, to restore competition lost as a result of the unlawful conduct.”  Id. at 5.  In that endeavor, she argued, “The Commission may require relief that prohibits otherwise lawful conduct, if such relief is necessary to prevent ongoing harm to competition.”  Id.  In support, she quoted from the Supreme Court’s decision in FTC v. Ruberoid Co., 343 U.S. 470, 473 (1952), in which the Court held,

[T]he Commission is not limited to prohibiting the illegal practice in the precise form in which it is found to have existed in the past. If the Commission is to attain the objectives Congress envisioned, it cannot be required to confine its road block to the narrow lane the transgressor has traveled; it must be allowed effectively to close all roads to the prohibited goal, so that its order may not be by-passed with impunity.

Id.  She explained, “The Court later gave a name to this concept: ‘those caught violating the [FTC] Act must expect some fencing in.’”  Id. at 6.

Commissioner Harbour also relied upon the Supreme Court’s opinion in Jacob Siegel Co. v. FTC, 327 U.S. 608, 612 (1946) in which the Court described the Commission as “the expert body to determine what remedy is necessary to eliminate the unfair or deceptive trade practices which have been disclosed.”  Id. at 5 (internal quotation marks omitted).  She explained that “the Court further stated that the Commission ‘has wide latitude for judgment’ and ‘wide discretion in its choice of a remedy deemed adequate to cope with the unlawful practices in . . . trade and commerce.’”  Harbour Stmt. at 5 (quoting Jacob Siegel, 327 U.S. at 613, 611).  Accordingly, “the Court concluded that ‘the courts will not interfere except where the remedy selected has no reasonable relation to the unlawful practices found to exist.’”  Id. (emphasis in original).

Commissioner Harbour then concluded, “In this case, extending the relief to the DDR2 SDRAM standard would be reasonably related to Rambus’s deceptive and exclusionary conduct” because “[i]n the ‘but for’ world, the SDRAM and DDR SDRAM standards would have been Rambus-free."  Id. at 6.  She explained, "Due to the path-dependent nature of JEDEC standard-setting, the inclusion of Rambus technologies in the first- and second-generation standards made it all but inevitable that Rambus technologies also would be included in DDR2. Rambus’s exclusionary conduct therefore facilitated the creation of Rambus’s DDR2 monopoly.”  Id.

She also concluded that the burden of proof in the remedy phase is “less stringent than in the liability phase, and the evidence must be weighed accordingly.  Finding a ‘reasonable relation’ to the unlawful practices requires less evidence than would be needed to establish the violation.”  Id. at 7.  Relying on United States v. E.I. DuPont de Nemours & Co., 366 U.S. 316, 334 (1961), she argued, “It is black-letter Supreme Court law that ‘once the Government has successfully borne the considerable burden of establishing a violation of law, all doubts as to the remedy are to be resolved in its favor.’”  Id. at 8.  Here, she placed particular emphasis on the fact that, although the Commission did not decide the issue in its Liability Opinion, Rambus’s asserted document destruction “should not be wholly ignored for remedy purposes” because it could have impeded the ability of the Complaint Counsel to come forward with relevant evidence.  Id.

In conclusion, she believed that the majority’s remedial order did not comport with market realities, and further unjustly enriched Rambus:  “the bottom-line result of the Commission’s remedy is this: Rambus will continue to reap financial benefits that are reasonably related to its successful subversion of JEDEC’s standards.”  Id. at 10.

Authored By:  Mona Solouki

(415) 774-3210

In two companion cases concerning the Robinson-Patman Act's prohibition of price discrimination, the Sixth Circuit holds that a loyalty program that is functionally available to competing purchasers does not violate the RPA.  Smith Wholesale Co., Inc. v. R.J. Reynolds Tobacco Co., 6th Cir. No. 05-6053, 2/27/07; M-K Grocery Co. v. Philip Morris USA, Inc., 6th Cir., No. 05-6481, 2/27/07 (unpublished).  Unlike other RPA decisions that have applied the functional availability doctrine to volume-based loyalty programs, these cases stand-out as one of the first occasions where a court has discussed in detail the circumstances in which a market share based loyalty program may or may not be functionally available and discriminatory.  The decisions reveal that a loyalty (or other discount) program that requires a purchaser to alter its business strategy or marketing decisions to obtain the best price does not render the discount functionally unavailable.

In the two cases, distributors claimed that the two leading cigarette manufacturers in the country, RJ Reynold's and Philip Morris' market-share discount programs constituted price discrimination in violation of Section 2(a) of the RPA.  The programs offered financial incentives to distributors who focused on defendants' "savings" brands.  "Savings" brands are second and third tier products priced lower than first-tier, premium products like Philip Morris' Marlboro and RJ Reynolds' Camel, Winston and Salem cigarettes.  RJ Reynolds' second and third tier cigarettes are sold under the brand  names "Doral", "Monoarch", "Best Choice", "Citation" and "Cardinal."  Plaintiffs sold a high volume of fourth-tier cigarettes, the lowest priced cigarette on the market.  Neither defendant makes or sells fourth-tier cigarettes. 

RJ Reynold's "Wholesale Partners Program" and Philip Morris' "Wholesale Leaders Program" offered three discount/rebate levels.  All distributors qualified for the first and lowest level discount, although that discount diminished over time.  A distributor would be eligible for the second and third level discounts and rebates if its share of defendants' savings brand cigarettes, in comparison to its share of other makers' savings brands, was high enough.  The exact share varied by geographic area.  Defendants made the discount levels known to all competing purchasers. 

The crux of plaintiffs' arguments in the two cases was that the higher level discounts were not functionally available because they were not realistically or practically achievable.  Plaintiffs claimed it was impossible to meet the higher market share percentages because they sold to retailers in lower income, rural areas that have a uniquely high demand for fourth-tier cigarettes, the cheapest available.  They alleged they could not reach the higher market share percentages without limiting their sales of fourth tier brands, and that it was not realistic or practical for them to do so because they are full-service distributors and retailers will take their business elsewhere if plaintiffs stopped selling fourth-tier cigarettes.  RJ Reynolds countered that it was possible for plaintiffs to obtain the best pricing:  plaintiffs could choose to curtail their sales of fourth-tier cigarettes and attempt to attain the higher discount/rebate levels or they could continue to promote fourth-tier cigarettes and receive a lower discount.

The Sixth Circuit affirmed summary judgment in favor of defendants.  To avoid redundancy, the court adopted and incorporated its legal conclusions in the Reynolds case to the M-K Grocery case.  The court first observed that market share discounts differ from volume based discounts because they "theoretically level the playing field by allowing competing purchasers of like commodities to participate on equal terms, regardless of size, because such discounts depend not on volume purchases, but on the percentage of purchases of a particular category of products."  Reynolds at 10.  Nevertheless, the court said, market share discounts may be administered in such a way that the incentives "cross the fine line from pro-competitive incentives to exclusionary, anti-competitive price discrimination".  Id.  The court offered additional guidance on market share discount programs.  Quoting from the Supreme Court's decision in Volvo Trucks, the court noted that price discrimination claims concerning market share discount programs should be evaluated on a case-by-case basis like all antitrust claims.  Reynolds at 10, quoting Volvo Trucks North America, Inc. v. Reeder-Simco GMC, Inc., 546 U.S. 164 (2006).  The court referred to the Supreme Court's suggestion in Volvo that the Court would not interpret discrimination where the allegedly favored purchasers were not power buyers, but also pointed out that the RPA's "applicability is not limited to big-buyer/small buyer cases, ..it is one of general applicability and prohibits discriminations generally".  Reynolds at 10, quoting Alan's of Atlanta, Inc. v. Minolta Corp., 903 F.2d 1414, 1422 (11th Cir. 1990). 

Taking up the key issue in the case, whether RJ Reynold's discount program was functionally available, the court quoted Krist Oil where the plaintiff faced a choice that was "not an inequity imposed by the pricing structure but a fundamental economic conundrum faced by all sellers,", i.e., "purchasers are left with a choice between selling more bottles at a lower price per bottle profit or selling fewer bottles at a higher profit for each."  Krist Oil Co., Inc. v. Bernick's Pepsi-Cola of Duluth, Inc, 34 F. Supp. 2d 852, 856 (W.D. Wis. 2005).  Considering its own decision in Bouldis v. U.S. Suzuki Motor Corp., 71 F.2d 1319, (6th Cir. 1983) the court noted that manufacturers may expect that not every dealer will participate in every incentive program.  A dealer may determine in the exercise of its business judgment whether to take advantage of a promotion.  In Bouldis, the plaintiff's inability to participate was due to its own cash flow and inventory problems.  There was no causal link between the defendant's program and plaintiff's alleged injuries.  Thus, plaintiffs had not established price discrimination. 

Returning to this case, the court observed that plaintiffs provided no statistical evidence or expert testimony to support the allegation that they could not increase their share of defendants' second and third tier brands because their customers served poorer areas with a uniquely high demand for fourth-tier cigarettes.  By contrast, RJ Reynolds presented evidence that showed that the average per capita income in the counties served by plaintiffs' customers exceeded that of the counties not served for most plaintiffs.  Two plaintiffs sold to customers in the same areas as other distributors who earned the highest level discounts available.  There was no evidence that anything other than the fact that plaintiffs' marketing decisions impacted their ability to obtain the best prices.  As in Krist Oil, the court said, this was not an inequity imposed by the pricing structure but a fundamental economic conundrum faced by all sellers.  Thus, the court accepted RJ Reynold's argument that attaining the higher discount levels was within plaintiffs' control; a distributor qualify for the higher discount levels by altering its sales mix at any time.  If it were otherwise, a distributor could claim that a discount is discriminatory because it requires the distributor to alter its business in some fashion.  In that case, manufacturers would have to customize discounts for its distributors and this would violate the RPA.  Here, "the capacity of plaintiffs to qualify for the best pricing was a matter of marketing strategy and brand prioritization, a choice inherent and unavoidable in multi-brand incentive programs".  This does not, the court held, give rise to price discrimination.  Plaintiffs' failure to qualify for the higher discounts was the result of their own marketing decisions.  While there may be some risk in focusing on second and third tier cigarettes instead of fourth tier cigarettes, all of the distributors participating in the higher discounts would have to take the same risk.  The discounts were available to all customers, based on a nondiscriminatory formula, evenly administered and functionally available.  Therefore plaintiffs failed to establish price discrimination.

In addition to their RPA claim against Philip Morris, plaintiffs in the M-K Grocery case alleged Philip Morris' discount program constituted an attempt to monopolize and violated Section 2 of the Sherman Act.  The Sixth Circuit, in its unpublished opinion, upheld summary judgment of this claim.  Although Philip Morris's market share based on units sold was 49.6%, plaintiffs failed to show that Philip-Morris had monopoly power.  Each time Philip-Morris lost market share, it responded by lowering prices.  The average price of its premium cigarettes was lower than its competitors' premium brands.  Likewise, there was no evidence that Philip-Morris had the power or could control other firms' output.  Unable to establish this element of a Section 2 violation, plaintiffs' attempted monopolization claim failed as a matter of law.

Authored By:  Heather Cooper

(213) 617-5457

hcooper@sheppardmullin.com

On March 1, the European Commission ("EC") sent a Statement of Objections ("SO") to Microsoft for failing to comply with certain of its obligations under the March 2004 Commission Decision.  Part of that Decision found Microsoft to have infringed the EC Treaty rules on abuse of a dominant position (Article 82) by leveraging its near monopoly in the market for PC operating systems onto the market for work group server operating systems.  Microsoft was required to disclose complete and accurate interface documentation on "reasonable and non-discriminatory terms" to allow non-Microsoft work group servers to interoperate with Windows PCs and servers.  The SO indicates the EC's preliminary view that there is no significant innovation in the interoperability information, rejecting as unfounded 1500 pages of submissions by Microsoft from December 2005 onwards, and hence that the prices proposed by Microsoft are unreasonable.

EC Competition Commissioner, Ms Neelie Kroes, said, “Microsoft has agreed that the main basis for pricing should be whether its protocols are innovative. The Commission's current view is that there is no significant innovation in these protocols. I am, therefore, again obliged to take formal measures to ensure that Microsoft complies with its obligations”.

Microsoft provides two separate licensing arrangements to companies wishing to obtain the interoperability information as foreseen by the 2004 Decision's remedy.  The first is a "No Patent Agreement" allowing licensees to use the protocols which together comprise the interoperability information, but without taking a license for patents which Microsoft claims necessary, a claim disputed by some third parties.  The second (the "All IP Agreement") combines this first license with a license for these disputed patents.  Companies, therefore, have a choice of agreement, depending on whether they consider they need a patent license.  Both licenses confirm that an assessment of the reasonableness of Microsoft's prices depends on whether there is innovation in the protocols, and, if there is, what is charged for comparable technologies in the market.  For both licenses, Microsoft divided the protocols into Gold, Silver and Bronze price categories based on the claimed degree of innovation.  Microsoft has already agreed that there is a fourth category of protocols, not necessarily innovative, for which there is no royalty fee.

The Commission's preliminary view is that there is virtually no innovation in the 51 protocols in the "No Patent Agreement" where Microsoft has claimed non-patented innovation, and that Microsoft's current royalty rates for this agreement are, therefore, unreasonable.  The EC took into account the advice of both the Monitoring Trustee, and its technical advisors, TAEUS, who both considered that there was no innovation in any protocol in the Gold and Silver categories.  These protocols represent more than 95% of the price of the total Technical Documentation.  The Trustee considered that of the total of 160 claims, only four, relating to relatively minor Bronze protocols, represented even a limited degree of innovation.

In relation to the "All IP Agreement", the Commission stated that it assumed that the existence of patents indicates some associated innovation.  However, it noted that the Monitoring Trustee considered that most of the information in this agreement related only to solving problems specific to Windows, and it would not improve the functionalities of the licensee's own operating systems.  Comparable technologies are available on a royalty-free basis. I n the few cases in which the Trustee considered that patented technologies may go beyond merely solving interoperability problems specific to the Windows environment, again royalty-free comparable technologies exist. The Commission's preliminary view is, therefore, that Microsoft's current royalty rates for its "All IP Agreement" are also unreasonable.

The EC has given Microsoft four weeks to respond to the SO, and will give the company the opportunity to present its case before an oral hearing.   If the EC is not satisfied that Microsoft's submissions alter its provisional conclusion, then the Commission may issue another Decision under Article 24(1) of Regulation 1/2003, imposing a daily fine on Microsoft, and in the event of continued non-compliance, the daily fine could be extended.

Authored By:  Neil Ray

(415) 774-3269

nray@sheppardmullin.com

A maker of concrete vaults that house telephone cables cannot add an exclusive dealing claim to the host of antitrust allegations it has leveled against SBC Services Inc., a California District Court judge has ruled.

Plaintiff Jensen Enterprises, Inc. sought to amend its complaint against SBC to add an exclusive dealing claim under Clayton Act Section 3, but U.S. District Court Judge Susan Illston denied the motion, saying that 9^th Circuit case law only allows such claims to be alleged against sellers, and SBC is in no sense a seller of the vaults.  Jensen Enterprises, Inc. v. Oldcastle, Inc., C-06-247 SI (N.D. Cal. Feb. 5, 2007).

Jensen makes and sells telephone utility vaults, concrete structures that are used to connect telephone cables from properties to telephone land lines.  According to the complaint, the companies that make these vaults usually sell directly to a developer, who then installs them and the accompanying telephone cable.  After installation is complete, according to the complaint, the property developer usually must resell the vaults and cable to an AT&T affiliate, and only then will the affiliate provide phone service.

Jensen alleges that defendants, three affiliates of AT&T, Inc.[1], conspired with another maker of the vaults, defendant Oldcastle, Inc., to eliminate competition and artificially inflate prices.

According to Jensen, the AT&T affiliates have named Oldcastle as the sole source of concrete vaults for connecting properties in California and Nevada to the AT&T networks in those states.  Jensen claims that Oldcastle, as the only authorized seller, charges property developers excessively high prices for its vaults -- prices that it could never charge if it had to face competition.  The developers must then resell the vaults to an AT&T affiliate at a very low price which, according to the complaint, the affiliate justifies by referring to prices in a sales contract between SBC and Oldcastle.

Thus, Jensen claims, Oldcastle enjoys windfall profits and AT&T affiliates effectively force property developers to subsidize their telephone network in California and Nevada -- all at the expense of excluded competitors and captive customers.  "These property developers are in the first instance captive purchasers who must buy dear from Oldcastle, and then they become captive resellers who must sell cheap to the local AT&T affiliate," the complaint alleges. 

Jensen claims the arrangement violates Sherman Act sections 1 and 2, California's Cartwright Act and the Nevada Fair Trade Practice Act and that it constitutes tortious interference with contracts and tortious interference with prospective economic advantage.  To this list, Jensen sought to add an exclusive dealing claim under Clayton Act section 3, which provides that "It shall be unlawful ... to … make a sale ... of goods ... on the condition ... that the ... purchaser ... shall not use or deal in the goods ... of a competitor ... where the effect ... may be to substantially lessen competition or tend to create a monopoly ...."

SBC opposed the amendment, citing McGuire v. Columbia Broadcasting System, 399 F.2d 902 (9^th Cir. 1968) for the proposition that a Section 3 claim cannot lie against a buyer in an alleged exclusive dealing arrangement.  "The language of the statute defines liability in terms of a person who makes a sale or contracts for sale and nowhere provides for liability of the buyer."  Id. at 906.  Another district court has observed that such a limitation is consistent with the "fundamental antitrust concept that the alleged sins of sellers should not be visited on buyers because of the risk of chilling competition."  Genetic Systems Corp. v. Abbott Laboratories, 691 F. Supp. 407, 415 (D.D.C. 1988).

Jensen argued that McGuire was inapplicable because buyers in the instant case are the property developers and contractors.  The District Court noted, however, that SBC was also a buyer of the concrete vaults, and that nowhere in the transaction is SBC a seller.  The court therefore denied plaintiff's motion to amend the complaint to add to the section 3 claim against SBC. (The court granted plaintiff's motion to add a section 3 claim against Oldcastle, which did not oppose the amendment).

Authored By:  Tyler M. Cunningham

(415) 774-3208

tcunningham@sheppardmullin.com

On February 26, 2007, the California Court of Appeal, Fourth District pulled the plug on the remaining wholesale electricity manipulation cases, based upon the California recent energy crisis.  See, Wholesale Electricity Antitrust Cases I & II, California Court of Appeal, Fourth District, Nos. 4204, 4205, February 26, 2007.

In late 2000, eighteen private treble damage class actions were filed against a series of defendants.  The defendants included groups of generators, sellers, or traders of electricity at wholesale.  The complaint alleged that the defendants manipulated, distorted, "gamed", and corrupted the wholesale electricity market in California, thus forcing consumers to pay electricity rates not based upon competitive market forces.  Citing and adopting the decisions of the Court of Appeals for the Ninth Circuit in Public Utility Dist. No. 1 of Snohomish County v. Dynergy Power Marketing, Inc., 384 F.3d 756 (9^th Cir. 2004) ("Snohomish") and Public Utility Dist. No. 1 of Grays Harbor County, Washington v. Idacorp, Inc., 379 F 3^rd. 641, 647 (9^th Cir. 2004) ("Grays Harbor"), the Court of Appeal upheld the sustaining of a demurrer without leave to amend, holding that the claims were preempted by the Federal Power Act ("FPA"), and the exclusive regulatory authority of the Federal Energy Regulatory Commission ("FERC").  In an alternative holding, the Court of Appeal also affirmed the trial court's determination that transactions involving interstate wholesale electricity markets are preempted under the FPA, and that the filed rate doctrine applies to the rates regulated pursuant to the authority of FERC.  The trial court entered judgment of dismissal, which the Court of Appeal affirmed.

The plaintiffs argued that in light of various changes in the FERC regulatory process, from filed rates to a market-based type of regulation pursuant to an Independent Service Operator ("ISO"), Congress could not have intended to preempt the field.  Plaintiffs relied upon Younger v. Jensen, 26 Cal. 3d 397 (1980) to contend that there was concurrent state antitrust regulation in the California wholesale interstate electricity market.  The trial court held, and the Court of Appeal affirmed, that Younger was distinguishable.  The trial court, and the Court of Appeal, relied primarily on the authority of the Ninth Circuit decisions cited above.  The Ninth Circuit decisions, as well as the Court of Appeal decision here, concluded that the plaintiffs' claims and prayer for relief would impermissibly require a "fair price" determination, and thus second guess the authority of FERC to determine what is a "fair and reasonable" rate.

The Court of Appeal reasoned that "the general rule disfavoring implied preemption"[1] was inapplicable, as here, there is a history of significant and pervasive federal regulation.[2]  As the field of interconnection relating to wholesale electricity distribution agreements has a history of significant federal presence, the presumption was held inapplicable.

The Court of Appeal held that the plaintiffs' proper course of action was to apply to FERC for redress and to argue that the prices approved by FERC pursuant to filed tariffs were not "just and reasonable," or that the defendants sold electricity in violation of the filed tariffs.[3]

Plaintiffs also argued that FERC had done a particularly poor job in regulating the California interstate wholesale electricity market, and that accordingly, state antitrust law principles should be applicable.  The Court of Appeal rejected the argument, and held that the issues as framed presented a "bright line easily ascertained between state and federal jurisdiction …".[4]  The Court of Appeal noted that even considering FERC's "difficult history", is has been provided with sufficient regulatory authority such that federal preemption principles must be applied.  It noted that FERC possesses "broad remedial authority to address anti-competitive behavior".[5]

The Court of Appeal recognized that the trial court's ruling that federal preemption applied was dispositive.  Nevertheless, for completeness, it held in the alternative that the filed rate doctrine was applicable.  It noted that in Grays Harbor[6] the Court of Appeal found that the market-based rates filed with FERC were adequate for the application of the filed rate doctrine.  It noted,

"The market-based rate regime established by FERC continues FERC's oversight of the rates charged.  FERC only permits power sales at market-based rates after scrutinizing whether the seller and its affiliates do not have, or have adequately mitigated, market power in generation and transmission and cannot erect other barriers to entry."[7]

It noted further that "this oversight is ongoing…".  The plaintiffs' allegations, the Court of Appeal observed "amount to requests for penalties for alleged anticompetitive conduct by defendants, and these potentially would interfere with FERC supervision of market-based rates and any enforcement activities allowed under FERC procedures."

Authored By:  Don T. Hibner, Jr.

(213) 617-4115

dhibner@sheppardmullin.com

FTC Kills Funeral Home Directors’ Attempt to Bury Competition

The Board, which the State of Missouri had empowered to pass regulations regarding funeral homes and services, had amended the regulations in 2004 to state that “No person other than a duly licensed and registered funeral director may make the following at-need arrangements with the person having the right to control the incidents of burial: . . . (C) sale or rental to the public of funeral merchandise, services or paraphernalia.”  Missouri statutes, however, explicitly provided that non-funeral homes had the right to sell caskets to the public, despite any regulation that the Board might pass.  The FTC, however, found that the new regulation, by itself, coupled with the Board’s power to seek injunctive relief, could discourage potential entrants into the casket market, and decrease competition.  The FTC noted that it had brought past complaints against funeral home associations that had attempted to ban other types of companies from selling caskets.

To resolve the complaint, the Board agreed to a consent decree that allowed the Board to keep the amended regulation, but required it to publish the text of the Missouri statute and a proviso stating in its newsletter, on its website, and in the magazine it regularly distributed to its members that the regulation did not prohibit non-funeral home from selling caskets.  The FTC also required the website to have a link to the FTC’s decision, to remain active for at least 5 years, and to make itself accessible to all regular search engines.

The order and decision are intriguing because they avoid the problem of mandating that a state organized and sanctioned self-governing body change its regulation and instead remedy the potential problem through a notice.  As the FTC’s complaint focused on the perception of the scope of the regulation rather than the regulation itself, this decision and order show a very focused remedy for a problem. 

FTC Approves Suit to Block Natural Gas Acquisition in Pittsburgh Area

The FTC voted 4-1 to approve a suit if necessary to stop Equitable Resources, Inc from acquiring The People’s Natural Gas Company, a subsidiary of CNG and Dominion Resources, Inc.  According to the complaint, the $970 million acquisition would result in a monopoly in the market for the transmission, distribution, and sale of natural gas in certain counties in Southwestern Pennsylvania, including around the Pittsburgh Area.  The press release accompanying the administrative complaint stated that the FTC would not file a complaint seeking to block the merger, unless the Public Utility Commission of Pennsylvania declined to block the acquisition on its own.

The concern for the FTC is Equitable’s proposed control over People’s in areas where the merger would result in a decrease in competition from 4 to 3, 3 to 2, or 2 to 1 competitors. The FTC acknowledged that the Pennsylvania PUC actually sets the rates charged to residential users, potentially blunting the pricing power of even a monopolist, but found that the merger could still result in higher prices.  First, businesses within the effected area would be unable to force Equitable and People’s to compete, leaving businesses in the area vulnerable to price increases.  Second, the FTC argued that Equitable and People’s had competed for residential customers in the past by providing rebates to the customers, thus decreasing the effective price paid by the residential customers despite the presence of the PUC.

The administrative complaint is interesting, because the FTC admits that it has no plans to file for a preliminary injunction so long as the PUC refuses to permit the merger to go forward.  Thus, if the Pennsylvania PUC were to decide that the merger was in the public interest, the parties still could not close, as the FTC would sue to stop the consummation.  Given the localized effects of the relevant product markets, the local distribution of natural gas to customers, one could argue that the Pennsylvania PUC would have just as great a concern about the welfare of the citizens of Pennsylvania as would the FTC.  In addition, by announcing that it had voted to permit the filing of suit seeking a preliminary injunction when one might not be necessary, the FTC would seem to cut off negotiations that could have resulted in further concessions by Equitable.  Thus, just as with the Missouri Funeral Home Directors decision discussed above, the FTC has decided to intervene in a very localized market where the state had already passed laws regulating the anticompetitive conduct at issue, perhaps reflecting a new, more aggressive stance towards enforcement.

Authored By:  Christopher Bowen

(202) 772-5348

cbowen@sheppardmullin.com