Summary

The Supreme Court has delivered its much anticipated[1] decision in Leegin v. PSKS, Inc.[2] and overruled the 96 year-old rule established in Dr. Miles Medical Co. v. John D. Park & Sons Co.[3] that made agreements between manufacturers and their distributors on the minimum resale price of the manufacturer's products, "per se" or automatically unlawful.  The Court held that the appropriate standard for testing the lawfulness of minimum resale price agreements, also known as resale price maintenance or RPM, is the rule of reason, not the per se standard.  Under the rule of reason, the courts evaluate the effects of a trade restraint on competition in the relevant antitrust market.  If a restraint's effects benefit competition between rival firms more than they injure competition, the restraint will be upheld.  Thus, the Leegin decision means that courts will now review RPM practices on a case-by-case basis.  Federal and state law enforcers and private plaintiffs will have the burden of proving that a RPM practice is anticompetitive, while manufacturers and distributors will need to show that their RPM practice is procompetitive.

Introduction

            For 96 years, the rule established by the Supreme Court in Dr. Miles made RPM practices per se unlawful under Section 1 of the Sherman Act.  A person who engaged in RPM was thus exposed to federal and state prosecution as well as private actions, criminal penalties including imprisonment, automatic treble damages, and liability for litigation costs and attorneys fees.  But on June 28^th 2007, in a 5-4 decision, the Court overruled its decision in Dr. Miles and held that RPM is not the kind of practice that fits the per se rule.  RPM does not "always or almost always tend[] to restrain competition and decrease output" and so the per se rule is not the appropriate standard for RPM.  In reaching this conclusion, the Court found that the reasons given in Dr. Miles did not justify the per se rule; that RPM can stimulate interbrand competition (competition among manufacturers selling different brands of competing goods) which is the antitrust laws' primary purpose; and that the legal doctrine of stare decisis did not compel adherence to Dr. Miles because the Sherman Act is treated in the manner of the common law, not statutory law.  Because the per se rule no longer applies, the Court held that the RPM should be subject to the rule of reason, "the accepted standard for testing whether a practice restrains trade in violation of § 1 of the Sherman Act".  Under this approach, the courts will consider all of the circumstances including the relevant business, the restraint's history, nature and effect, and especially, whether the businesses involved have market power.

The District Court Decision

            Leegin, like many manufacturers concerned with brand image and product merchandising, had established MSRP policies where the manufacturer in advance announces the terms and conditions upon which it will deal and the circumstances under which it will refuse to deal.  MSRP policies are lawful under United States v. Colgate & Co., 250 U.S. 300 (1919).  Colgate created a lawful alternative to the per se rule against resale price agreements in Dr. Miles.  Under Colgate, a purely unilateral MSRP policy escapes the per se rule in Dr. Miles because it lacks the element of "agreement" essential under § 1.

            Plaintiff PSKS, Inc., a women's clothing and accessories store doing business as Kay's Kloset, sued Leegin, a manufacturer of women's accessories, for engaging in RPM with other retailers in violation of § 1.[1]  PSKS, Inc. demonstrated that Leegin's MSRP policy went beyond the lawful boundaries of Colgate by suggesting joint, not unilateral action, that Leegin solicited agreement from retailers by asking them to "pledge" to follow the policy, and that Leegin assured retailers that others were following the policy.  The district court refused to allow any expert testimony on behalf of the defense which asserted that MSRP can be pro-competitive and was so here.  Instructed pursuant to Dr. Miles, the jury found that defendant Leegin engaged in RPM with retailers and therefore violated § 1 of the Sherman Act.  Leegin was ordered to pay PSKS, Inc. $3.6 million in trebled damages as well as $375,000 in attorney's fees and costs.

The Fifth Circuit Decision

            On appeal, Leegin did not challenge the jury's finding that it entered into RPM agreements with retailers.  Rather, Leegin challenged the per se standard.  The Fifth Circuit rejected Leegin's arguments, explaining it was bound by Dr. Miles to apply the per se rule.  The court noted the length of time that the rule has stood since Dr. Miles was decided and the Supreme Court's consistency in applying it. [2]  The court also rejected Leegin's argument that the jury should be permitted to consider either that Leegin's pricing practices were procompetitive or its expert economic testimony.  Neither, the court held, were relevant where the per se rule applies because the rule presumes competitive harm.[3]

The Supreme Court Decision

            In overruling Dr. Miles, the Supreme Court first noted that the per se rule is confined, and should only apply, to trade restraints that "always or almost always" tend to restrict competition and decrease output, such as horizontal agreements among competitors to fix prices or divide markets.[4]  A restraint condemned by the per se rule must have manifestly anticompetitive effects and lack any redeeming value, the Court added.[5]  The per se rule, the Court said, is only appropriate after courts have had considerable experience with the type of restraint at issue.[6]  A departure from the rule of reason and the application of the per se rule should only be based on a demonstrable economic effect rather than formalistic line drawing.[7]

            For all these reasons, the Court held that the per se rule established in Dr. Miles was wrong.  Dr. Miles, the Court noted, was decided not long after the Sherman Act was enacted, when the Court had little experience with antitrust analysis.  Furthermore, the Court in Dr. Miles did not rely on any demonstrable economic effect.  Instead, it relied upon a formalistic legal doctrine, the common-law rule that a general restraint upon alienation is ordinarily invalid.  The common-law rule against restraints on alienation, especially in the age that Dr. Miles was decided, the Court observed, was usually associated with land, not chattels, and involved policy concerns that are not relevant to the use of vertical distribution restraints in the American economy today.[8] 

            In addition, the Court recognized that "economics literature is replete with procompetitive justifications for a manufacturer's use of resale price maintenance."[9]  Thus, RPM is not "manifestly anticompetitive" and does not always injure competition.  Manufacturers may have procompetitive justifications for RPM, such as to enhance efficiency, encourage retailers to invest in consumer services or promotional efforts that aid the manufacturer's position against rival manufacturers, help retailers develop a quality reputation encouraging consumers to buy from such sellers, and induce retailers to perform by discouraging free-riding.[10]  The Court stated that RPM may facilitate market entry for new firms and brands.  Thus, while resale price maintenance may reduce intrabrand competition (competition among distributors selling the same manufacturer's products), it might simultaneously stimulate interbrand competition (competition among rival manufacturers).  Interbrand, not intrabrand, competition is the primary purpose of the antitrust laws, the Court held.

            The Court likewise determined that stare decisis did not compel it to uphold Dr. Miles, a key difference with the dissent.  Stare decisis is not as significant in this case, the majority said, because this case concerns the Sherman Act and "the general presumption that legislative changes should be left to Congress has less force with respect to the Sherman Act".[11]  "Congress intended," the Court said, "§ 1 of the Sherman Act to give courts the ability 'to develop governing principles of law' in the common-law tradition".[12]  The Sherman Act's prohibition of  "restraints of trade" in § 1 should "evolve to meet the dynamics of present economic conditions."[13]<

Applying the Rule of Reason to RPM, and What Now?

            Although the Court abandoned the per se rule of illegality, it did not make RPM per se lawful.  Instead, the Court established a rule of reason standard for RPM, meaning that each RPM practice will be evaluated on a case-by-case basis.  This approach is appropriate, the Court explained, because while RPM can have procompetitive effects in some cases, it can have anticompetitive effects in others.  RPM could discourage manufacturers, the Court noted, from lowering prices to retailers, discourage retailers from offering lower prices to consumers, facilitate price fixing among competing manufacturers or competing retailers, or be abused by a powerful manufacturer or retailer.[14]

            The Court provided some guidance on how the lower courts should treat vertical price restraints.  It advised the lower courts to be diligent in eliminating anticompetitive uses of vertical price restraints[15] and to take into account certain factors.  These factors include the number of manufacturers using vertical price restraints in a given industry (few manufacturers with little market power or a single manufacturer with market power would not likely facilitate a manufacturer cartel); the source of the restraint (if the restraint is retailer driven, it may be more likely that the restraint facilitates a retailer cartel); the nature of the restraint; and especially important, whether the manufacturer or retailer has market power (a manufacturer with market power could, for example, use RPM to give retailers an incentive not to sell the products of smaller rivals or new entrants).  Although this could involve a lengthy investigation, the Court suggested that a "quick-look" analysis or presumptions might suffice once the courts gain experience in applying the rule of reason to RPM.[16] 

Manufacturers that have market power, that operate in a mature, highly concentrated industry, or that could be pressured to participate in  a manufacturer cartel or facilitate a retailer cartel, may find it prudent to stick to unilateral MSRP policies rather than test the post-Leegin waters at the risk that a court could find that its RPM practice is injuring competition and therefore violates § 1.  Some manufacturers may also want to wait and see whether the States, as in the case of Illinois Brick,[17] move to adopt Leegin "repealers" and retain the per se rule.[18]  Manufacturers should thus consult antitrust counsel to help determine whether their use of RPM would pass the applicable legal test.

Authored By:

Heather M. Cooper

(213) 617-5457

hcooper@sheppardmullin.com

Michael W. Scarborough

(415) 774-2963

mscarborough@sheppardmullin.com

Introduction

On June 18, 2007, the United States Supreme Court ruled in a 7-1 decision that investment banks are immune from antitrust scrutiny in connection with syndication and marketing techniques employed in underwriting initial public offerings, Credit Suisse Securities (USA) LLC v. Billing  (No. 05-1157) 127 S.Ct. 2383, 2007 U.S. LEXIS 7724.  Finding that "permitting plaintiffs to dress what is essentially a securities complaint in antitrust clothing" would pose a "serious conflict between, on the one hand, application of the antitrust laws and, on the other, proper enforcement of the securities law," the Court held that federal securities laws and regulation impliedly preclude the application of antitrust laws to the underwriting activities at issue.  Id. at *35.  Writing for the majority, Justice Breyer emphasized that there is a fine, complex line separating activities permitted and forbidden under the securities laws, and that the Securities and Exchange Commission is far better qualified to determine the legality of such conduct than judge and juries in antitrust cases.  Id. at *27-34.

Background

Plaintiffs in Credit Suisse alleged what the Second Circuit described as an "epic Wall Street conspiracy."  Sixty plaintiff investors claimed that between March 1997 and December 2000, ten of the nation's leading underwriting firms entered into illegal contracts regarding the marketing and distribution of securities sold through IPOs, thereby grossly inflating the post-IPO prices of the securities and violating Sherman Act Section 1.  Specifically, plaintiffs claimed that the investment banks unlawfully agreed with one another that they would not sell shares of popular IPO securities to a buyer unless that buyer committed (1) to buy additional shares of that security later at escalating prices ("laddering"); (2) to pay unusually high commissions on subsequent security purchases from the underwriters; or (3) to purchase from the underwriters other less desirable securities ("tying").  See id. at *6-7.

The district court granted a motion to dismiss by defendants, holding that the securities laws impliedly repealed federal and state antitrust laws with respect to the alleged underwriting conduct.  In re Initial Pub. Offering Antitrust Litig., 287 F. Supp.2d 497 (S.D.N.Y. 2003).  Judge Pauley found that implied immunity was appropriate because the SEC, both directly and through its pervasive oversight of the National Association of Securities Dealers and other self-regulatory organizations, either expressly permits the conduct alleged or has the power to regulate the conduct such that a failure to find implied immunity would "conflict with an overall regulatory scheme that empowers the [SEC] to allow conduct that the antitrust laws would prohibit."  Id. at 523.  See also id. at 499 ("Any other result would force the defendants to navigate the Scylla of securities regulation and Charybdis of antitrust law.").

The Second Circuit reversed, and reinstated plaintiffs' claims, finding no specific Congressional intent to immunize the challenged conduct, either express or implied.  Billing v. Credit Suisse First Boston Ltd., 426 F.3d 130, 172 (2005).  The Second Circuit rejected defendants' argument that implied antitrust immunity arises from a potential specific conflict between the antitrust laws and the securities laws, and further held that the securities laws were not sufficiently "pervasive" to immunize defendants' alleged conduct.  Id. at 166-172 ("Congress knows how to immunize regulated conduct from the antitrust laws.  To date, it has not done so here . . .").

The Supreme Court's 7-1 Decision

The Supreme Court reversed the Second Circuit, holding that the securities laws implicitly preclude the application of the antitrust laws to the conduct alleged by plaintiffs.  Relying on a trilogy of high court cases on the law of antitrust immunity in the securities context, Justice Breyer explained in the majority opinion that an implied repeal of the antitrust laws is found where there is a "plain repugnancy" between the antitrust and securities laws.  Credit Suisse, 2007 U.S. LEXIS 7724 at *13-15.  Stated otherwise, the Court held, the test is whether the securities law and an antirust complaint are "clearly incompatible."  Id. at *21.  Under this test, antitrust claims are precluded implicitly when the challenged conduct is:  (1) squarely within the "heartland of securities regulations"; (2) within the authority of the SEC to regulate; (3) the subject of "active and ongoing agency regulation"; and (4) likely to create "a serious conflict between the antitrust and regulatory regimes."  Id. at *37.

Justice Breyer, joined by Chief Justice Roberts and Justices Scalia, Souter, Ginsburg and Alito, explained that the first three of these factors were easily met in Credit Suisse, as the defendants' joint efforts to promote and to sell newly issued securities are central to the proper functioning of well-regulated capital markets; the law grants the SEC authority to supervise these activities; and the SEC has continuously exercised its legal authority to regulate the conduct of the general kind at issue.  Id. at *22-24.

In considering the fourth factor, regarding the existence of a serious conflict between the antitrust and securities regimes, the Court assumed the truth of plaintiffs' contention that the SEC has disapproved, and will continue to disapprove, the specific conduct challenged by plaintiffs under the antitrust laws.  Id. at *26-27.  Nonetheless, the Court found a serious conflict because "an antitrust action in this context is accompanied [1] by a substantial risk of injury to the securities markets and [2] by a diminished need for antitrust enforcement to address anticompetitive conduct."  Id. at *35.

As to the first concern, the Court held that antitrust actions such as Credit Suisse threaten serious securities-related harm because "only a fine, complex, detailed line separates activity that the SEC permits or encourages (for which respondents must concede antitrust immunity) from activity that the SEC must (and inevitably will) forbid (and which, on respondents' theory, should be open to antitrust attack)."  Id. at *27.  In light of this fine line, "[i]t will often be difficult for someone who is not familiar with accepted syndicate practices to determine with confidence" how to categorize challenged practices.  Id. at *27.  The Court noted that evidence tending to show unlawful antitrust activity and evidence tending to show lawful securities marketing activity may overlap or prove identical, and that there would be a high risk of inconsistent results from different non-expert judges and different non-expert juries.  Id. at *30-31.  Collectively, observed the Court, "these factors suggest that antitrust courts are likely to make unusually serious mistakes" in applying antitrust law to securities-regulated conduct.  Id. at *31-32.  According to the Court, this "threat of antitrust mistakes" (and the resultant treble damages) would discourage underwriters from a wide range of joint conduct that the securities laws permits or encourages – "[a]nd therein lies the problem."  Id. at *32.

The Court also concluded that "any enforcement-related need for an antitrust lawsuit is unusually small" in the securities context.  The Court justified this conclusion with observations that (a) the SEC actively enforces the rules and regulations that forbid the conduct in question; and (b) investors harmed by underwriters' unlawful practices may bring lawsuits and obtain damages under the securities laws.  Id. at *34.  In addition, the Court expressed reluctance to potentially undermine the newly tightened procedural requirements for plaintiffs filing securities actions by allowing such suits to proceed "in antitrust clothing."  Id. at *35.

Notably, the Supreme Court rejected the compromise resolution suggested by the Solicitor General, SEC and DOJ in a unified amicus submission (the SEC and DOJ submitted opposing amicus positions during the Second Circuit appeal).  The Court declined to follow the Government's suggestion to remand the case to the District Court to determine whether plaintiffs' allegations of prohibited conduct could be separated from conduct allowed by securities regulations or whether the SEC-permitted and SEC-prohibited conduct are "inextricably intertwined."  Id. at *35-37 (noting Solicitor General's fear that overly broad finding of implied immunity could preclude application of antitrust law to underwriting syndicate behavior such as overt market division).  Justice Breyer explained that this proposed disposition did not convincingly address the Court's concerns, i.e.:

[1] the difficulty of drawing a complex, sinuous line separating securities-permitted from securities-forbidden conduct, [2] the need for securities-related expertise to draw that line, [3] the likelihood that litigating parties will depend upon the same evidence yet expect courts to draw different inferences from it, and [4] the serious risk that antitrust courts will produce inconsistent results that, in turn, will overly deter syndicate practices important in the marketing of new issues.

Id. at *36-37.

Justice Stevens filed a concurring opinion in which he concluded that the challenged underwriting agreements did not violate the antitrust laws on the merits, and "should be treated as procompetitive joint ventures for purposes of antitrust analysis," with no need for an analysis of implied immunity.  Id. at *38-40 (Stevens, J., conc.).  Justice Thomas lodged a dissenting opinion disagreeing with the majority's conclusion that the Securities Act and Securities Exchange Act are silent on the preclusion of antitrust claims, instead finding that both "contain broad saving clauses that preserve rights and remedies existing outside of the securities laws."  Id. at *41 (Thomas, J., diss.).  Justice Kennedy, whose son is a managing director of Credit Suisse in New York, recused himself from the case.

Looking Forward

Credit Suisse is an important win for the securities industry.  Although securities industry players must conform to a substantial and developing body of SEC rules, they now can be less concerned with potentially devastating treble damages attacks on their market activities under the antitrust laws.

Participants defending antitrust claims in other highly regulated industries no doubt will push for the same significant regulatory deference shown the SEC in Credit Suisse, and indeed, the logic of Credit Suisse may reach beyond the securities industry.  Complicated line-drawing abounds in many regulated industries, and judges and juries may be poorly equipped to decide a wide variety of matters on which they pass judgment.  Moreover, to the chagrin of Justice Stevens, in Bell Atlantic Corp. v. Twombly (No. 05-1126, May 21, 2007) 127 S.Ct. 1955, 2007 U.S. LEXIS 5901 and Credit Suisse, the Roberts Supreme Court has shown a willingness to confine the reach of antitrust claims based on the perceived burdens of antitrust litigation and the risk "that antitrust courts are likely to make unusually serious mistakes."  See Credit Suisse, 2007 U.S. LEXIS 7724 at *40-41 (Stevens, J., conc.).

Authored by:

Michael W. Scarborough

(415) 774-2963

mscarborough@sheppardmullin.com

DOJ Obtains Consent Degree forcing Divestiture in Monsanto/Delta & Pine Land

On May 31, the Department of Justice Antitrust Division announced that it had reached a settlement with Monsanto, resolving the objections that the Division had with Monsanto's purchase of Delta & Pine Land ("Delta").  Numerous interest groups had watched the merger closely, as it involved the vertical integration of the largest producer of cotton seed traits (favorable growing characteristics that are introduced into cotton seeds via genetic engineering) with the largest producer of cottonseeds, and the horizontal integration of two cottonseed producers.

Although Monsanto had first attempted to merge with Delta in 1998, Monsanto had abandoned the merger, and the two companies had continued to operate independently.  Monsanto continued to partner with Delta in developing new varieties of cottonseeds, as Monsanto held a monopoly on the technology for developing new cotton traits, while Delta had a 50% share of the U.S. market for cottonseeds and an 85% share of the market in the Southeastern United States.  Delta, however, continued to work on new variants of cottonseed with Syngenta, DuPont, and Monsanto.  Monsanto also owned the Stoneville Pedigreed Seed Company ("Stoneville"), which also produced cottonseeds.

After Monsanto announced that it would purchase Delta for $1.5 billion, various interest groups and competitors, such as the National Black Farmer's Association and DuPont, expressed serious concerns, asserting that the acquisition could raise prices and reduce choices for traited cottonseeds and foreclose competition from other developers of cotton traits.  DuPont and Syngenta, having worked closely with Delta to develop the next generation of cottonseeds, worried that their investments would be lost and they would be foreclosed from the development of the next generation of cottonseeds.

In its settlement, the Antitrust Division sought to address the objections made against the acquisition.  First, the consent decree requires Monsanto to divest itself of Stoneville along with twenty lines of seed germplasm, to a buyer approved by the Division.  Second, to resolve the vertical issues, Monsanto must divest certain of the cottonseed lines developed by Delta to Syngenta, including the ones that incorporate Syngenta's insect resistant technology.  Finally, the consent decree requires Monsanto to make changes to its third party licenses, removing restrictions "on the ability of licensees to develop, market, or sell cottonseed containing traits of companies other than Monsanto."

The settlement is noteworthy for a number of reasons.  For one thing, many commentators thought that the Division should challenge the merger on the basis of the vertical issues posed by combining the largest cotton trait developer and the largest producer of cottonseeds.  Also, the agreement may assuage the asserted vertical concerns by permitting other cottonseed companies currently doing business with Monsanto to partner with other trait developers.  Thus, the Division imposed conditions beyond simple divestiture.

FTC Requires Divestitures in Rite Aid's Purchase of Eckerd and Brooks

On June 4, the FTC announced that it had reached a settlement with Rite Aid to resolve the antitrust issues arising from the purchase of Eckerd and Brooks.  The consent decree requires Rite Aid to divest 23 drug stores in eight New England and Mid-Atlantic states to other drug store chains.

On August 23, Rite Aid announced the purchase of The Jean Coutu Group USA in exchange $3.5 billion in the form of cash and a 30% ownership interest in Rite Aid.  The Jean Coutu Group owned and operated 1,858 Eckerd and Brooks pharmacies in the United States, while Rite Aid owned 3,319 drug stores.  The FTC, after issuing a second request and coordinating its investigations with state authorities, issued a complaint and proposed consent decree.

The consent decree and analysis defined the relevant market as "the retail sale of pharmacy services to cash customers in local markets."  The FTC specifically differentiated cash customers from customers covered by insurance, finding that cash customers generally could not obtain prescription insurance coverage in response to an increase in price, and that discount cards and internet prescription sales were not an adequate check on prices either.  In addition, the Commission stated that the profit margins on cash customers were generally much higher than they were on customers covered by insurance.  Despite the higher profit margins, the "vast majority" of a pharmacy's profits came from other sources, meaning that an increase in price charged to cash customers probably would not spur entry by a competing pharmacy, according to the Commission.  It found that further inhibiting entry was the small size of many of the towns, the zoning restrictions on building a new pharmacy, and the limited availability of new pharmacists.  In each of the twenty-three markets that the FTC defined, the merged firm would have had between approximately 50% and 100% of the market for pharmaceutical sales to cash customers.  To resolve the issues in the 23 markets, the FTC required Rite Aid to divest three of the stores to Kinney Drug Incorporated, one store to Big Y Foods, Incorporated, one store to Weis Markets Incorporated, six stores to Walgreen Company, and twelve to Medicine Shoppe International Incorporated.

Although the analysis given by the FTC indicates that each of the up-front buyers is "competitively and financially viable," Weis, Kinney, and Big Y are fairly small, with Weis operating 150 supermarkets, only some of which are pharmacies; Kinney operating 80 pharmacies; and Big Y operating 50 pharmacies.  CVS, the largest pharmacy in the United States, is absent from the list of buyers.