United States: What Companies Don't Know Can Hurt Them: An Introduction To The Basics Of U.S. Antitrust And Competition Laws

Originally published in the State Bar of Texas Corporate Counsel Section Newsletter, Winter 2013

What Companies Don't Know Can Hurt Them: An Introduction To The Basics Of U.S. Antitrust And Competition Laws¹

I. Purpose of U.S. Antitrust Laws

A fundamental precept to American economic philosophy is free-market competition. With that in mind, the United States antitrust laws prohibit anti-competitive behavior and unfair business practices. The laws are intended to protect economic freedom and opportunity by promoting competition in the marketplace. They are based on the principle that competition fosters the most efficient allocation of resources, the lowest prices, and the highest quality goods and services. The Antitrust Division of the United States Department of Justice ("DOJ") and the Federal Trade Commission ("the Commission" or "FTC") (when referred to collectively, "the Agencies") are the federal agencies charged with the responsibility of enforcing the U.S. antitrust laws.

II. U.S. Antitrust Laws Focus on Certain Types of Anticompetitive Conduct

The U.S. antitrust laws make unlawful every contract, combination or conspiracy in restraint of trade.² They apply to virtually all industries and to every level of business, including manufacturing, transportation, distribution, and marketing. The three basic U.S. federal antitrust laws - the Sherman Act, the Clayton Act, as amended, and the Federal Trade Commission Act (the "FTC Act") - each attempt to prohibit anticompetitive practices and prevent unreasonable concentrations of economic power that stifle or weaken competition.

A. The Sherman Act³

The Sherman Act was enacted in 1890 and was the first major legislation passed to address oppressive business practices associated with cartels and oppressive monopolies. Section 1 of the Sherman Act prohibits every contract, combination or conspiracy between two or more companies which exerts an unreasonable restraint on trade or commerce.⁴ This section prohibits horizontal agreements to restrain trade (i.e., agreements among competitors) as well as vertical agreements (i.e., agreements between buyers and sellers).

Section 2 of the Sherman Act makes it unlawful for any person to "monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations. . ."⁵ Section 2 establishes three offenses, commonly termed "monopolization," "attempted monopolization," and "conspiracy to monopolize."⁶ Unlike Section 1, Section 2 of the Sherman Act does not require proof of an agreement. Instead, Section 2 requires proof that the violator: (1) possesses monopoly power,⁷ and (2) acquired, enhanced or maintained that power by use of exclusionary conduct.⁸

If applied literally, Section 1 of the Sherman Act would invalidate practically every commercial arrangement. Accordingly, in 1911 the United States Supreme Court ruled that, despite the all embracing statutory language, the Sherman Act reached only those trade restraints which are unreasonable.⁹ This analysis, referred to as the rule of reason, has since been the hallmark of judicial construction of the antitrust laws. Under its aegis, to determine the reasonableness of challenged conduct, courts weigh the anticompetitive consequences of the conduct against the business justifications upon which the conduct is predicated and the putative procompetitive impact.¹⁰

In contrast to the rule of reason, the "per se" rule makes certain practices conclusively unreasonable, and thus illegal. Among these practices are agreements to fix certain prices, to divide markets among competitors, to rig bids, or to impose certain group boycotts. Other practices, such as exclusive dealing arrangements or restraints in a supply chain that restrain commerce, may be unlawful if they are judged unreasonable.

Restraints of trade can be categorized as horizontal or vertical. A horizontal agreement is an agreement for cooperation between two or more direct competitors operating at the same level in a particular industry, while a vertical agreement involves participants who are not direct competitors because they are at different levels in the distribution chain. Thus, a horizontal agreement can be among manufacturers or retailers or wholesalers, but it does not involve participants from across the different groups. A vertical agreement involves participants from one or more of the groups - for example, a manufacturer, a wholesaler, and a retailer. Establishing whether an agreement is horizontal or vertical can be significant in determining whether to apply a per se rule of illegality or the rule of reason. For example, horizontal market allocations are per se illegal, but vertical market allocations are subject to the rule of reason.

Although Courts have interpreted the Sherman Act's broad mandate differently over time, recent judicial opinions show a growing consensus about the following principles regarding Section 2:

1. Unilateral conduct is outside the purview of Section 2 unless the actor possesses monopoly power or is likely to achieve it;

2. Mere possession or exercise of monopoly power is not an offense;

3. Acquiring or maintaining monopoly power through assaults on the competitive process harms consumers and is to be condemned;

4. Mere harm to competitors - without harm to the competitive process - does not violate Section 2; and

5. Competitive and exclusionary conduct can look alike - indeed, the same conduct can have both beneficial and exclusionary effects - making it hard to distinguish conduct that should be deemed unlawful from conduct that should not.

B. The Clayton Act¹¹

The Clayton Act was enacted in 1914 and expands on the general prohibitions of the Sherman Act. While the Sherman Antitrust Act laid the groundwork for antitrust regulation in the United States, the Clayton Act clarified the rules surrounding unlawful anti-competitive practices. The Clayton Act's coverage includes tying agreements, requirement contracts, exclusive dealing arrangements, price discrimination, mergers and acquisitions and interlocking boards of directors.

• Section 2: Section 2 of the Clayton Act, also known as the Robinson- Patman Act, targets price discrimination. This section makes it unlawful for any seller of goods "to discriminate in price between different purchasers of commodities of like grade and quality . . . where the effect of such discrimination may be substantially to lessen competition or tend to create a monopoly in any line of commerce, or to injure, destroy, or prevent competition with any person who either grants or knowingly receives the benefit of such discrimination, or with customers of either of them. . . ."¹² Section 2 protects smaller businesses by limiting the large company's ability to command discriminatory discounts through its purchasing power.¹³
• Section 3: Section 3 makes it unlawful to lease, sell or contract to sell goods, or to fix a price: "on the condition, agreement or understanding that the lessee or purchaser thereof shall not use or deal in the goods . . . of a competitor or competitors of the lessor or seller, where the effect . . . may be to substantially lessen competition or tend to create a monopoly in any line of commerce."¹⁴ The types of arrangements that may violate Section 3 include exclusive dealing arrangements, requirements arrangements, and tying arrangements.
• Section 7: Section 7 applies to mergers and acquisitions and prohibits an entity from acquiring all or any part of the stock or assets of another entity where "the effect of such acquisition may be substantially to lessen competition or to create a monopoly."¹⁵ Section 7 also applies to tender offers and the formation of joint ventures.
• Section 7A: The Clayton Act was amended in 1976 by the Hart-Scott- Rodino Antitrust Improvements Act¹⁶ to establish pre-merger notification requirements. Section 7A requires all parties to certain transactions (including mergers, acquisitions or transfers of securities or assets, and grants of executive compensation) to notify the FTC and the Antitrust Division of the DOJ of their intentions, receive a finding from the Agencies that the transaction will not adversely affect U.S. commerce under the antitrust laws, and wait a designated period of time before consummating those transactions.¹⁷

C. FTC Act¹⁸

The FTC Act was enacted alongside the Clayton Act in 1914 to prohibit "unfair methods of competition, and unfair or deceptive acts or practices . . ."¹⁹ This law, in effect, authorizes the Commission to enforce the other antitrust laws and, in addition, serves as a "gap filler" to challenge conduct not covered under the Sherman Act or the Clayton Act. Thus, conduct which does not violate the other federal antitrust laws may, nevertheless, be unlawful under the FTC Act.²⁰

D. State Antitrust Laws

Most states have enacted their own antitrust laws to prohibit anticompetitive conduct affecting commerce within their borders and to supplement enforcement of federal antitrust laws. In Texas, the Texas Free Enterprise and Antitrust Act is similar to the federal Sherman Act, with provisions much like Section 1 and 2 of the Sherman Act and Section 7 of the Clayton Act.²¹ While state and federal antitrust laws are conceptually similar, the codification of state antitrust laws varies widely from state to state. For example, some state antitrust laws, such as those in Texas, substantially track the language of their federal counterparts, whereas other states only incorporate select sections of federal antitrust laws, recite specific types of prohibited acts, or include new areas of substance entirely.²² The Texas attorney general has the authority to investigate possible antitrust violations using civil investigative demands for documents and testimony. For example, in U.S. v. Apple, Inc., et al., Case No. 12-cv-2826 (SDNY June 2012), Texas was among a number of plaintiff states in a settlement with Simon & Schuster where the defendants agreed to pay over $2.5 million to the states for their costs of investigation and litigation and other related costs. In many cases, state antitrust laws are more expansive than the federal antitrust laws in terms of the amount and quality of prohibited conducted. The interpretation of state antitrust laws may, but will not always, substantially mirror the federal antitrust laws.

III. Enforcement

Both the Antitrust Division of the DOJ and the Commission have broad investigatory powers to uncover antitrust violations. The FTC can file antitrust lawsuits in either federal court, or in an administrative hearing. Only the Antitrust Division of the DOJ can bring charges under the Sherman Act.

A company can find itself involved in an antitrust investigation in a number of ways, including a formal civil investigative demand by an enforcement agency and subpoenas - either as a target of an investigation or as a third-party participant. A company may also find itself as a complainant before the antitrust authorities, attempting to seek investigation into certain conduct and activities they find problematic in the industry or to block a potential merger transaction that the company deems harmful.

Penalties for violating the Sherman Act can range from civil to criminal penalties; an individual violating these laws may be jailed for up to three years and fined up to $1 million per violation. Corporations may be fined up to $100 million per violation. The Clayton Act authorizes private parties such as consumers or business firms injured by antitrust violations to sue the violators in court for three times the amount of damages actually suffered.²³ These treble damages can also be sought in class-action antitrust lawsuits. Private plaintiffs may also seek attorneys' fees and other litigation costs. Under the FTC Act, the Commission is empowered, among other things, to investigate and issue orders that the violator cease and desist its anticompetitive practices.²⁴ Finally, state antitrust laws often prohibit the same type of conduct as the federal antitrust laws.

As a result, the penalties state laws impose are also similar and can range from criminal to civil sanctions.

IV. Conclusion

It is imperative that companies of all sizes be familiar with the general principles of the U.S. antitrust laws, as well as similar laws in any other jurisdiction in which the company does business. Officers, directors, managers, sales and marketing personnel and any other company employees or representatives should handle all communications with competitors with extreme caution. Even casual conversations between competitors can turn into improper agreements to set prices, allocate customers or otherwise restrain trade, all of which are illegal under the antitrust laws and can have grave consequences. To avoid possible criminal and civil litigation, companies must (1) familiarize themselves with the antitrust laws, (2) provide employees with periodic antitrust compliance training, and (3) consult with an experienced antitrust attorney to address periodic antitrust compliance matters and any issue that may raise a potential antitrust concern.

Footnotes

1 This article is taken from a series of topics presented at "What Companies Don't Know Can Hurt Them: A Primer on Key Antitrust Issues," a seminar held at Vinson & Elkins' Houston office on September 19, 2012. "What Companies Don't Know Can Hurt Them: A Primer on Key Antitrust Issues" provided a practical approach to dealing with emerging legal developments and key issues in antitrust law.

2 15 U.S.C. § 1 et seq.

3 Id. §§ 1-7.

4 Id. § 1.

5 Id. § 2.

6 See, e.g., 1 Section of Antitrust Law, Am. Bar Ass'n, Antitrust Law Developments 225, 317 (7th ed. 2012).

7 One of the key components of monopolization is the possession of monopoly power. While courts have not established a precise market share threshold to infer the existence of monopoly power, market shares of at least 50% are typically necessary to establish an inference of monopoly power. There are instances, however, where parties with market shares as low as 40-45% have been scrutinized in smaller markets with fewer competitors, particularly in an attempted monopolization case.

8 The mere existence of a high market share in and of itself does not violate Section 2. The antitrust laws do not prohibit entities from simply possessing a high market share - or even profiting from monopoly power - provided that it was power gained through natural growth or business acumen as opposed to exclusionary or predatory conduct. See United States v. American Tobacco Co., 221 U.S. 106 (1911) (holding that Section 2 of the Sherman Act does not ban mere possession of a monopoly; but instead bans the unreasonable acquisition and/or maintenance of a monopoly).

9 Standard Oil Co. of New Jersey v. United States, 221 U.S. 1 (1911).

10 Courts and enforcement agencies apply a three-step test to govern analysis under the rule-of-reasons analysis. First, a plaintiff must establish a prima facie case by showing that the restraint produces tangible anticompetitive harm, a showing that usually consists of proof of "actual detrimental effects" such as increased price or reduced output. Second, the defendants must prove that their agreement produces "procompetitive" benefits that outweigh the harm implicit in plaintiff's prima facie case. And third, even if the defendants can make such a showing, the plaintiff can still prevail by proving that the defendants can achieve the same benefits by means of a "less restrictive alternative."

11 15 U.S.C. §§ 12-27.

12 Id. § 13(a).

13 The general rule against price discrimination does not apply: (1) where there is a cost justification, (2) where it is done to meet the competition (i.e., to meet an equally low price of a competitor), and (3) in response to changes in market conditions. Id.

14 15 U.S.C. § 14.

15 Id. § 18.

16 Id. § 18a.

17 Once all parties to a transaction submit completed filings and pay the filing fee (generally $45,000 per transaction imposed upon the acquiring person), there is a 30-day waiting period before the transaction may be completed. The government has the option of extending the waiting period by making a formal request for additional information if the transaction appears to them to present anticompetitive concerns. The waiting period may also be terminated prior to the end of the 30 days if the parties request early termination at the time of filing and if the government elects in its discretion to do so. Id. § 18a (a)-(b), (d)-(e).

18 Id. §§ 41-58.

19 Id. § 45.

20 The Commission applies a broad standard to determine whether conduct violates the FTC Act. An act or practice is unfair where it (1) causes or is likely to cause substantial injury to consumers, (2) cannot be reasonably avoided by consumers, and (3) is not outweighed by countervailing benefits to consumers or to competition. FEDERAL RESERVE SYSTEM, DIVISION OF CONSUMER AND COMMUNITY AFFAIRS, CONSUMER COMPLIANCE HANDBOOK, Federal Trade Commission Act - Section 5: Unfair or Deceptive Acts or Practices (last updated June 2008), available at http://www.federalreserve.gov/boarddocs/supmanual/cch/ftca.pdf . An act or practice is deceptive where (1) a representation, omission, or practice misleads or is likely to mislead the consumer, (2) a consumer's interpretation of the representation, omission, or practice is considered reasonable under the circumstances; and (3) the misleading representation, omission, or practice is material. Id. Consequently, it may be an antitrust violation to engage in any business practice that can reasonably be termed "predatory" or "unfair" or which unreasonably restrains the economic liberty of a third party.

21 See TEX. BUS. & COM. CODE § 15.02 et seq. The statute permits private action, attorney fees and intervention by the Attorney General. Id. § 15.21. There is no requirement for premerger notification akin to the federal Hart-Scott- Rodino Act.

22 Texas looks to federal judicial interpretations of the Sherman Act in applying its state antitrust law. Id. § 15.04 (providing that the Texas Antitrust Act "shall be construed in harmony with federal judicial interpretations of comparable federal antitrust statutes.").

23 Section 4 of the Clayton Act states: "any person who shall be injured in his business or property by reason of anything forbidden in the antitrust laws may sue therefore in any district court of the United States ... and shall recover threefold the damages by him sustained, and the cost of suit, including a reasonable attorney's fee." In addition, Section 15 of the Clayton Act empowers the Attorney General, and Section 13(b) of the FTC Act empowers the Commission, to seek a court order enjoining consummation of a merger that would violate Section 7 of the Clayton Act.

24 More specifically, the Commission is authorized to: (a) prevent unfair methods of competition, and unfair or deceptive acts or practices in or affecting commerce; (b) seek monetary redress and other relief for conduct injurious to consumers; (c) prescribe trade regulation rules defining with specificity acts or practices that are unfair or deceptive, and establishing requirements designed to prevent such acts or practices; (d) conduct investigations relating to the organization, business, practices, and management of entities engaged in commerce; and (e) make reports and legislative recommendations to Congress.

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