On the flight back from my spring break ski trip, I had a chance to read the recent Tenth Circuit opinion reversing the insider trading conviction of former Qwest CEO, Joseph Nacchio. Mr. Nacchio had been convicted of 19 counts of insider trading, sentenced to six years in prison (plus two years’ supervised release), fined $19 million, and ordered to disgorge $52 million more. In a 2-1 decision authored by Judge McConnell, the Tenth Circuit reversed Nacchio’s conviction because of the district court’s exclusion of expert testimony by Dan Fischel (my corporations prof). The court also concluded that retrial will not constitute double jeopardy because a properly instructed jury could have found Nacchio guilty of insider trading. To reach that conclusion, the court had to delve extensively into the law of insider trading and the evidence presented at trial.

Here are a few thoughts on the decision.

Fischel’s Expert Testimony

The court was right to insist that Nacchio be allowed to present Prof. Fischel’s expert testimony. The government’s basic claim against Nacchio was that he sold Qwest stock after he learned that the company’s revenues were largely comprised of non-recurring sources, implying that the company would have a hard time meeting projected earnings. Nacchio maintained that he sold the stock not because he was trying to avail himself of an inflated stock price but because he wanted to diversify after he exercised soon-to-expire stock options. He also contended that the specific information to which he was privy (i.e., that much of Qwest’s revenue was non-recurring) was not “material” non-public information because the market didn’t react when the information was publicly disclosed.

Prof. Fischel was to testify (1) that Nacchio’s trading pattern was more consistent with a diversification strategy than with an attempt to profit from inside information and (2) that the stock price effect of the disclosure concerning Qwest’s non-recurring revenue suggested that the information wasn’t material. The district court ruled that Prof. Fischel wasn’t properly disclosed as an expert witness and that, in any event, his testimony wouldn’t “assist the trier of fact.”

I don’t want to get into the expert disclosure rules (where the district court apparently ignored distinctions between the criminal and civil contexts), but it seems clear to me that the district court was just wrong on the question of whether Fischel’s testimony would help a jury. Having taught Business Organizations a few times, I’ve seen that many smart, educated people are not aware of (1) why diversification is so important (and thus why sophisticated investors always diversify) and (2) how stock prices immediately incorporate material information. Fischel’s testimony would undoubtedly help jurors understand Nacchio’s defense. (More on this aspect of the decision from Jay Brown.)

Two Wrongs Don’t Make a Right (…as I said earlier)

One of Nacchio’s arguments was that his knowledge of pending deals with the government — deals that would have boosted Qwest’s revenue — immunized him from insider trading liability. This undisclosed “good news,” he argued, negated the materiality of the undisclosed fact that much of Qwest’s revenue was non-recurring. Moreover, he contended, the fact that he knew this information shows that he did not act with scienter (an intent to deceive).

I previously expressed skepticism about Nacchio’s defense. In a post titled Nacchio’s Puzzling (Innovative?) Defense, I wrote the following:

Is Nacchio claiming that it was OK for him to sell while in possession of material non-public bad news regarding company prospects because he also possessed material non-public good news? Is this a “two wrongs make a right” theory?…

Nacchio’s defense (or this part of it, at least) is that two “wrongs” do make a right because the second piece of non-public information to which Nacchio was privy when he traded (i.e., the likelihood of the lucrative defense contracts) would make the first piece (i.e., various bits of bad news at the company) immaterial. In other words, the theory seems to be that the totality of non-public information of which Nacchio was aware would not be something a rational investor would consider important in deciding how to invest (and thus would not be material), for Nacchio’s private negative information was counterbalanced by private positive information.

…I’m not optimistic for Nacchio.

It seems my skepticism was warranted. Upholding the district court’s decision to prohibit Nacchio from presenting classified information about the alleged government contracts, the Tenth Circuit quickly disposed of the “two wrongs” theory:

[E]ven if the classified information were presented and established what he said it would, it could not exonerate Mr. Nacchio as he claims. Essentially, Mr. Nacchio argued that undisclosed positive information can be used as a defense to a charge of trading on undisclosed negative information. We disagree. … If an insider trades on the basis of his perception of the net effect of two bits of material undisclosed information, he has violated the law in two respects, not none.

An Opening to Challenge Rule 10b5-1

Nacchio claimed that his sales were not illegal insider trading because he did not make them “on the basis of” material non-public information. Even if he possessed such information when he sold his stock, the information, he insists, did not cause the sales; he would have made them anyway in order to exercise his options and achieve diversification. Thus, the sales were not “on the basis” of material non-public information.

If one were to look only to the securities regulations, Nacchio’s position would seem doomed. The SEC’s Rule 10b5-1 states that any securities trade made while “aware” of material non-public information is made “on the basis” of such information, unless the trade was made pursuant to some securities trading plan executed before the trader became aware of the information. Thus, if you possess material non-public information, and you trade, and your trade wasn’t pursuant to some previously executed contract or instruction or “written plan for trading securities,” you’re in trouble.

But that rule would seem to read the “scienter” element out of an insider trading claim. The law prohibiting insider trading, Section 10(b) of the Securities Exchange Act, prohibits only “manipulative or deceptive device[s] or contrivance[s]” that contravene SEC rules. This language would seem to require some intent to deceive (or at least recklessness), and the Supreme Court has interpreted it accordingly. In a prominent insider trading case, Dirks v. SEC, the Court was careful to emphasize that “[t]here must also be ‘manipulation or deception’ in an insider trading case,” and it said the following about the required scienter element:

Scienter — “a mental state embracing intent to deceive, manipulate, or defraud” — is an independent element of a Rule 10b-5 violation. Contrary to the dissent’s suggestion, motivation is not irrelevant to the issue of scienter. It is not enough that an insider’s conduct results in harm to investors; rather, a violation may be found only where there is “intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities.”

(Note 23, citations omitted.)

Thus, it would seem that proof of “intent to deceive, manipulate, or defraud” is required to establish illegal insider trading. Rule 10b5-1 would impose liability without such proof, but that rule, promulgated by the SEC, can’t go further than the authorizing statute, Section 10(b). The rule, then, may be invalid. (For more on this, check out this from Prof. Bainbridge.)

On remand, Nacchio is almost certain to challenge the validity of Rule 10b5-1. Judge McConnell’s opinion invites him to do so. It notes that “[s]ome commentators maintain that [Rule 10b5-1] (the authority of which has not been resolved by any circuit) is unlawful because it effectively eliminates fraud from the liability standard.” Watch for Nacchio’s lawyers to seize on this argument when fighting over jury instructions on remand.

A Lenient Materiality Standard

Finally, the Tenth Circuit’s decision is notable for adopting a very lenient standard for the “materiality” of non-public information. The non-public information at issue in this case suggested that earnings targets were overstated. Nacchio argued that this information was not material because the degree of overstatement was so slight. He contended that the degree of overstatement was 1.4% of total revenues; the government maintained that it was 4.2%. In either event, Nacchio’s argument would seem to be fairly strong. The Tenth Circuit noted that “[c]ourts regularly look to the magnitude of a potential loss in determining whether knowledge of it is material,” and it cited an unpublished Ninth Circuit decision concluding that “[revenue] projections which are missed by 10% or less are not generally actionable.” (In re Apple Computer, Inc., 127 F. App’x 296, 204 (9th Cir. 2005).) It also quoted from an SEC accounting bulletin in which the accounting staff assessed the “common ‘rule of thumb’ among accountants ‘that the misstatement or omission of an item that falls under a 5% threshold is not material in the absence of particularly egregious circumstances.’” In that bulletin, the accounting staff stated:

The use of a percentage as a numerical threshold, such as 5%, may provide the basis for a preliminary assumption that–without considering all relevant circumstances–a deviation of less than the specified percentage with respect to a particular item on the registrant’s financial statement is unlikely to be material. The staff has no objection to such a “rule of thumb” as an initial step in assessing materiality. But quantifying, in percentage terms, the magnitude of a misstatement is only the beginning of an analysis of materiality; it cannot appropriately be used as a substitute for a full analysis of all relevant considerations.

Given the accounting staff’s unwillingness to create a real safe harbor for revenue deviations of less than 5% of projections, the Tenth Circuit was unwilling to conclude that Nacchio’s non-public information about a likely revenue shortfall (which the court measured at 4.2% of projections) was immaterial. So much for the rule of lenity.

(More on the materiality ruling here.)

***

So what’s going to happen on remand? Jay Brown thinks Nacchio’s prospects are pretty grim. I’d perhaps offer a brighter prognosis. If Nacchio can get the court to reject Rule 10b5-1’s “awareness” standard, so that the government must prove that the material non-public information caused the sales at issue AND if Fischel sets forth a convincing case for why the stock trades must have been accomplished as part of a diversification strategy, not as an attempt to profit from inside information, then he has a shot.

Of course, those are some big ifs. Nacchio’s best approach might be a plea bargain. I, of course, hope he doesn’t do so so that a court can directly confront Rule 10b5-1’s overbreadth.

With all of the recent talk of the “optimal regulatory structure” and proposals about regulatory consolidation and reorganization (here is Glom Blogger David Zaring on the Big Reorg), I wonder if the discussion might carry over into antitrust and the recurring “dual enforcement” question. 

As some of our readers may know, both the DOJ and FTC share the responsibility of enforcing the federal antitrust laws.  This dual agency structure comes under attack from time to time.  As one might expect, the primary critique is that the dual structure creates inconsistent enforcement and other inefficiencies.  However, the consensus view appears to be that the institutions have evolved in ways that mitigate those inefficiencies.  At least, the agencies have reduced these inefficiencies to the point that there is apparently no constituency harmed by them sufficiently to create a large demand for reform.  Judge Posner describes the structure as “peculiar, to say the least … yet pretty harmless.”  The Antitrust Modernization Committee recently took on the issue of dual enforcement (Chapter II.A) and concluded that while “although concentrating enforcement authority in a single agency generally would be a superior institutional structure, the significant costs and disruptions of moving to a single-agency system at this point in time would likely exceed the benefits.”  In other words, if it ain’t broke (or is only broke a little bit) … It should be noted that three AMC Commissioners did recommend consolidation of all antitrust enforcement powers with the DOJ.

The discussion of benefits and costs of regulatory competition and consolidation in antitrust has been largely anecdotal.  For example, Judge Posner draws on his own experiences with state AGs (read: bad ones), though he does marshal some other evidence, in arguing that states should be stripped of their antitrust enforcement powers except for under narrow circumstances.  I think it is a fairly open empirical question whether and to what extent regulatory competition between federal agencies (or federal agencies and the state AGs)  has been a net good or bad for consumer welfare.   If any rigorous empirical work has been done on this question in antitrust, I haven’t seen it or have forgotten it.  My instinct is that the evidence is likely to differ in those two cases with state v. federal overlapping enforcement generating larger and more robust negative effects (and little or no effect as between the federal agencies).

First, David Bernstein reports on GMU’s very productive hiring season which includes the additions of Helen Alvare, Laura Bradford, T.J. Chiang, Jonathan Mitchell, Adam Mossoff, Chris Newman, David Schleicher, and Jay Verret.  

Second, Brian Leiter reports that Jonathan Klick (Florida State), a graduate of GMU Law (and of the economics department with a Phd in 2003) and former Levy Fellow, has accepted a tenured offer at the University of Pennsylvania Law School.  Congratulations to both Jon and Penn!

Today, Treasury Secretary Henry Paulson is set to present some comments about the Treasury’s Blueprint for Financial Regulatory Reform, released on Saturday.  (A summary of the proposal is here.) 

The summary of the proposal report provides:  “In this report, Treasury presents a series of “short-term” and “intermediate-term” recommendations that could immediately improve and reform the U.S. regulatory structure. The short-term recommendations focus on taking action now to improve regulatory coordination and oversight in the wake of recent events in the credit and mortgage markets. The intermediate recommendations focus on eliminating some of the duplication of the U.S. regulatory system, but more importantly try to modernize the regulatory structure applicable to certain sectors in the financial services industry (banking, insurance, securities, and futures) within the current framework.” 

I have a few comments on the proposals:

1.  The report contemplates consolidation of market regulators for the securities markets and the commodities markets.  This is a difficult issue.  Intuitively, I like the notion of consolidating regulation, as the regulatory authority dealing with commodities (the CFTC) and regulators of the general securities markets (SEC) both regulate the markets for securities.  That said, commodities regulation is (a) incrementally more sophisticated than the regulation of the generic securities markets due to the increased complexity in products, their evolution, and their likely economic/market impact and (b) different in sort than the regulation of plain vanilla securities.  Moreover, my impression – based on my experience working at the SEC and my experience as a corporate/securities/business scholar – is that the CFTC does a bit of a better job than the SEC in avoiding political pressure.  (Think about it – while we can easily recall a series of SEC Chairmen resigning under pressure, can we easily recall a series of CFTC Chairmen resigning under pressure?)  Is it sensible to combine agencies and lose that market niche insulation?

2.  The motivation for Treasury’s proposals strikes me as questionable.  The report summary says:  “Market conditions today provide a pertinent backdrop for this report’s release, reinforcing the direct relationship between strong consumer protection and market stability on the one hand and capital markets competitiveness on the other and highlighting the need for examining the U.S. regulatory structure.”  Indeed, the argument was made in connection with last spring’s Paulson report that the US capital markets are becoming less competitive, in part due to mis-regulation (and overregulation).

 But the argument that the US capital markets are becoming less competitive continues to be the subject of robust academic debate.  (For example, Howell Jackson, Jack Coffe, Kate Litvak, and Don Langevoort, all very credible scholars, expressed differing views on the issue at the AALS annual meeting this past year.)  I, for one, do not believe that the US capital markets are becoming less competitive.  Instead, I believe that the overseas markets are becoming *more* competitive.  That is not a bad thing, nor is it reason to overhaul US market regulation.  In reality, maybe the increasing competitiveness of overseas capital markets counsels in favor of our holding the status quo, to see how things shake out with the fundamentals that make the overseas markets increasingly competitive in the short term.

To that end, the report summary says “[g]lobalization of the capital markets is a significant development. Foreign economies are maturing into market-based economies, contributing to global economic growth and stability and providing a deep and liquid source of capital outside the United States. Unlike the United States, these markets often benefit from recently created or newly developing regulatory structures, more adaptive to the complexity and increasing pace of innovation.”  Until we know how these more newly developed regulatory structures fare in the long term, is seems unwise to jump to action to keep up with them.    Moreover, the summary of Saturday’s report indicates that its authors looked closely at the UK, Australia, and Netherlands financial markets regulatory regimes in designing the proposals in the report.  Basing reform of the US capital markets on regulation in the UK, Australia, and the Netherlands, however, does not strike me as sound.  If we are entertaining notions of wholesale reform, why not instead pin down what the conceptual optimal model would look like, as opposed to mining for inspiration from other regulators?  That said, the report purports to so do, to a degree, as discussed below in point three. 

3.  The report touts a new “objectives based regulatory approach.”  This approach, however, while radically different from the current US capital markets regulatory structure in terms of how it is implemented, is nothing new in terms of goals.  (Indeed, the summary says the new structure is motivated in part by “the convergence of financial services providers and financial products has increased over the past decade.  Financial intermediaries and trading platforms are converging.   Financial products may have insurance, banking, securities, and futures components.”  But wasn’t this dealt with in the Gramm- Leach-Bliley Act?  Why now do we need to revisit what appears to have been sensible reform less than a decade ago?)

The report summary says “[l]argely incompatible with these market developments is the current system of functional regulation, which maintains separate regulatory agencies across segregated functional lines of financial services, such as banking, insurance, securities, and futures,” and the report instead argues for an objectives based regulatory scheme, based on the objectives of “[m]arket stability regulation…, [p] rudential financial regulation…, and [b]usiness conduct regulation.”  But our current functional regulatory scheme operates with a focus on these exact objectives.  A consolidation of power into one regulatory authority for each objective seems to do nothing other than allow for (a) tunnel vision by a given objective’s regulator and (b) decreased input in terms of how to regulate to the goal of meeting these objectives.  With respect to point “b,” I believe that it is useful to have the leaders at the SEC, the CFTC, and the Federal Reserve all making calls to each other, giving input to the President and Congress, and agitating for ways to secure better regulation.  Yes, there is tension and a bit of repetitive regulation, but it seems to me that that is healthy when dealing with a matter as important as the United States capital markets.

4.  I have not worked through exactly how Saturday’s report proposes, if at all, to restructure the actual Board of Governors of the Federal Reserve System.  I will note, however, that I am generally leery of restructuring the Federal Reserve, both in terms of authority and operation.  Part of what makes the Federal Rserve work is the fact that the Governors serve for 14 year terms, allowing for insulation from political pressure (to a degree) and a link between immediate decision-making and longer-term implications.  (Contrariwise, the SEC Commissioners are usually long gone before the fall-out from their decisions becomes manifest.)  The Federal Reserve System has worked well for almost 100 years.  Does it really make sense to tamper with it?   

5.  To paraphrase, “regulate in haste and repent in leisure.”  I am never thrilled to see a massive proposal for overhaul and reform on the heels some major business or economic event.  Did the aftermath of the Sarbanes-Oxley Act (which is an act that I support, by the way) teach us nothing?

David Zaring and Gordon Smith have some interesting comments over on the ‘Glom, as does Larry Ribstein on his blog.

For at least two years, my boys (Liam, 9 and Ollie, 6) have been clamoring for a pet chinchilla. While perusing craigslist a few days before Ollie’s birthday, I ran across a listing for a 18-month-old chinchilla that came with a cage and all accessories (including a dust bather!) for a mere $75. Better yet, he was living less than one mile from my house. I had to teach that night so I dispatched my wife to check him out as a possible birthday present for Ollie. She brought the boys with so of course they insisted on getting Ripley (the Chinchilla). I arrived home from class to find Ripley and his large cage sitting in our dinning room. I don’t think Ripley liked me because he’d make a high pitched noise any time a wandered near his cage. I equated it with cat hissing.

Around 7:00 a.m. the next morning, I was awoken by screaming and wailing. It seems Laim took Ripley out of his cage to hold him. Ripley promptly jumped out of Liam’s arms and scampered under our couch. My wife lifted the couch in an effort to capture Ripley, but as she was lifting Ripley apparently attempted to scamper through the space between the back edge of the couch and the floor which was quickly shrinking as my wife lifted. Unfortunately for us all, Ripley was crushed and died instantly. Elapsed time from his arrival at our house until his death: 11 hours.

We decided that a chinchilla is not the best choice for a pet. As a replacement, we went with a dog, in part because he’s too big to scamper under the couch. Anyone in the market for a chinchilla cage? It comes with a dust bather!

One last issue with respect to ex ante competition and merger analysis.  What if it could be demonstrated convincingly that XM and Sirius payments to automobile manufacturers. The DOJ hints at this possibility in the press release:

XM and Sirius engaged in head-to-head competition for the right to distribute their products and services through each car company. As a result of this competitive process, XM and Sirius have provided car manufacturers with subsidies and other payments that indirectly reduce the equipment prices paid by car buyers to obtain a satellite radio.

The general approach of the Merger Guidelines is that efficiencies and consumer welfare benefits in product markets outside the relevant market don’t count for the purposes of Section 7 analysis.  I understand that some arbitrary rules about the scope of the competitive effects analysis must be made in order to make the problem tractable, but I tend to think the exclusion of these benefits from the calculation doesn’t make any sense.

The DOJ leaves open the possibility here that these subsidies would be passed on to consumers in the form of “indirectly” lower prices for the satellite radio equipment and so one might think of these as “in the relevant market.”  But in my analysis of slotting contracts with Ben Klein involving payments to multi-product retailers like supermarkets, we show that one reason why supermarkets prefer to receive lump sum payments rather than wholesale price reductions is that the supermarket is not forced to pass on the payments in the form of lower prices on the particular product.  In other words, a slotting fee on Coca-Cola is not likely to be passed on in the form of lower prices on Coca-Cola. There is little doubt that the payment is ultimately passed on to consumers in the competitive retail environment, however.  Supermarkets pass on these payments in the form of various price and non-price benefits on margins that will have the greatest impact of store traffic and inter-retailer competition.  For example, supermarkets may use payments to subsidize lower prices on staples that drive inter-store substitution or non-price amenities like a deli, longer hours, etc.

The point is that the economics of pass-through of these ex ante payments in the multi-product retailer context is much more complex.  However, the Merger Guidelines limit the complexity by arbitrarily limiting consideration of efficiencies to those within the relevant product market (in my example above, soda) and not including the other benefits accumulated by consumers as a result of the payments.  This is odd from a consumer welfare perspective.  One can understand the 2 year timing limitation as an arbitrary but necessary mechanism for limiting the complexity of antitrust analysis or the operation of some discount rate on future consumers.  I think a reasonable argument can be had about the merits of this approach given our limited ability to make predictions into the future (see generally Katz & Shelanski on the topic of Mergers and Uncertainty).

But I view the limitation on “out of market” consumer welfare benefits as less defensible in the context of multi-product retailers as in this slotting fee situation.  If the payments on Coca-Cola are passed on along some other price or non-price dimension, it is generally the same consumers accumulating the benefits and there is very little doubt that these payments are passed through in competitive retail environments.  To know that economic theory and empirical evidence suggests that these payments are improving consumer welfare — the very same class of consumers in the supermarket — but prevent consideration of those benefits as an efficiency strikes me as both arbitrary and perverse.

Geoff and Paul like the result in XM/ Sirius but are puzzled by the DOJ press release, in particular as it pertains to analyzing ex ante competition, or “competition for the field,” in the form of payments to automobile manufacturers to adopt their services. Geoff thinks the DOJ’s press release contains some funny language appearing to suggest that the existence of exclusive contracts meant that there was not competition. I think the relevant language is in the second sentence of the press release:

The Division reached this conclusion because the evidence did not show that the merger would enable the parties to profitably increase prices to satellite radio customers for several reasons, including: a lack of competition between the parties in important segments even without the merger …

Geoff correctly notes that the press release clarifies the DOJ’s position on ex ante competition a bit. The DOJ appears to understand that competition for the field is important in this market, but concludes that margin of competition has been exhausted until 2012 when the relevant exclusives expire. Paul’s critique of the DOJ press release is of a similar nature: why would the DOJ emphasize that there was a lack of competition between the parties on this margin? I agree with both of them that the press release is a bit odd — but for some reasons not discussed as of yet. I also want to take on Paul’s invitation to discuss the slotting allowance analogy to these payments and highlight some general issues about merger analysis and ex ante competition.

First, the press release. What strikes me as odd about the release is that you have to read pretty far into it to get to the discussion of market definition. And everybody knows the central issue in this case was whether this was a 2-1 merger or other terrestrial and other forms of radio were in. Why did the DOJ lead with the somewhat more fact intensive and complex point about competition for the field, noting the expiration dates of the contracts in 2012, and pointing out that the automobile distribution channel was an increasingly important part of the satellite radio market? A few guesses:

• The DOJ leads with the most fact intensive part of its analysis to demonstrate that it really did its homework here, understands the satellite radio market, how it has changed over time, and the role that these sole source arrangements play in the competition between XM and Sirius.
• Market definition is the more natural lead for obvious reasons. But there just isn’t enough variation in the price data and consumer switching (at least with non-confidential data) to show off the DOJ’s attention to analytical detail with the market definition point. Though note that if one concludes the market definition includes terrestrial radio, the competitive analysis is basically done.
• Another reason one might lead with the competition for the field point is that suggesting that the presence of exclusives means that firms are not competing avoids the critique that the DOJ is reflexively non-interventionist — it is certainly not the standard “Chicago” position on competition for the field

Again, these are all just idle observations. But it does strike me as a conscious choice to design the press release this way instead of leading with the obvious market definition point.

Second, the role of timing. The DOJ goes to great lengths to point out a few timing issues that play a central role in its competitive analysis. For instance, that the exclusive contracts would not expire until 2012 and therefore ex ante competition was exhausted until then. As Paul notes, the inference from the expiration dates on the contracts to the notion that competition was non-existent (or perhaps not significant) on that margin is wrong. It is certainly not the standard approach to competition with exclusives in the single firm context where the duration of the exclusives is a factor in the rule of reason analysis but not even presumptively illegal much less conclusive that competition is absent. As a matter of economics, Paul is absolutely right that this ex ante competition was not absent simply because expiration dates on the contracts were in the future. Firms can breach exclusive contracts. Firms can compete for future customers. Those customers contracts can come up for expiration at different times (were they all up in 2012?). And of course, they can also compete again in anticipation of expiration in 2012. I think the charitable and probably intended reading of the DOJ release is that competition in this margin was largely completed, while existent, but practically insignificant.

Timing comes up again in the context of technological change and entry:

The likely evolution of technology played an important role in the Division’s assessment of competitive effects in the longer term because, for example, consumers are likely to have access to new alternatives, including mobile broadband Internet devices, by the time the current long-term contracts between the parties and car manufacturers expire.

So, while there is no significant competition between XM and Sirius on this margin, it doesn’t really matter because the world is likely to change before 2012 anyway. Fine. But again, if market definition and entry and dispositive, why lead with the ex ante competition point? And as far as entry considerations go, the Merger Guidelines limit consideration of entry to that which is likely to occur within two years. I wonder if that means two years from the time of the closing of the investigation or from the time of the merger proposal in this context given the wait time for a decision?

Third, mergers and ex ante competition generally. There are some interesting issues here about ex ante competition and merger analysis more generally. For example, Paul asks why the DOJ would do so much to emphasize the negligible impact of the competition between XM and Sirius on consumer behavior in the car market and asks whether the agencies would say the same thing about slotting contracts in the grocery retail industry (a subject I’ve written about, e.g. here and here). I don’t think they would. One certainly wouldn’t argue that the fact that consumers don’t switch supermarkets based on what exact allocation of baby food, spices, or frozen foods they carry justifies the inference that there is no relevant ex ante competition between manufacturers in those industries. So I’m not quite sure why so much emphasis on this fact other than to demonstrate that the DOJ investigated this market in great detail.

I can’t seem to get my comment on Geoff’s XM-Sirius post below to go through, so I’ll just post it:

I would still disagree with the DOJ when they say “there is not likely to be significant competition…through the car manufacturer channel for many years.”  As mentioned, the exclusive contract is competition.  Even though they aren’t negotiating new contracts now, the competitively agreed upon prices and rebates are still in effect through 2012.  That doesn’t end competition, it extends it.  In addition, if there was no merger in the future and both companies were still in business when 2012 rolled around, they would again compete for the exclusive contracts.

I think the DOJ made the right decision.  However, I would have said that even though some aspect of competition for auto manufacturers between the two companies would end due to the merger, in general the relevant market is much broader than just satellite radio (which is the most important factor).

Also, why would the DOJ make it seem like it matters that there’s no evidence that competition between XM and Sirius affect’s customer’s choices of which car to buy?  Even if no customer would ever choose one car over another on the basis of its satellite radio, XM and Sirius would still compete for the customers each auto manufacturer “controls” (term used loosely).  This is similar to competition for grocery store shelf-space (either exclusively or non-exclusively) to acquire the consumers each respective store “controls.”  Our resident Mr. Shelf Space, can tell me whether he agrees or disagrees.

Grinols and Mustard (2006) answer “Yes” in their ReStat article.  Douglas Walker rebuts and Grinols and Mustard reply in the latest issue of Econ Journal Watch — which you should be reading.  The debate largely involves issues of measurement error and endogeneity, e.g. accounting for the possibility that crime cause casinos, and is accessible to non-economists.

The Washington Post is reporting that the long-embattled Sirius/XM merger has received DOJ approval (FCC approval still pending) (HT: David Fischer).  About time, I’d say (it’s been two years).  See all of the ToTM posts on the topic here. 

Opposition to this merger has been rooted in what, to me, is a tortured conception of market definition:  If satellite radio doesn’t compete with terrestrial radio (to say nothing of Internet radio, podcasts and much more), then I’ll eat my hat (a ToTM tradition).

I do want to draw attention to something in the WaPo article, however, which I find quite disturbing (and, I hope, taken out of context).  WaPo reports,  

The Justice Department, in a statement explaining its decision, said the combination of the companies won’t hurt competition because the companies are not competing today. Customers must buy equipment that is exclusive to either XM or Sirius, and subscribers rarely switch providers.

“People just don’t do that,” Assistant Attorney General Thomas Barnett said in a conference call with reporters.

Excuse me?  Did the Assistant AG just seem to say that, because people who subscribe to Sirius rarely switch to XM and vice versa that the two companies don’t compete?  I’m pretty sure this must be a misquote.  Surely Barnett has read Demsetz and knows about “competition for the field.”  Even if no user ever switched between providers, competition between providers for each new user’s allegiance–to say nothing of competition for dominance in a network industry–would exert just as much competitive pressure as if users changed their service regularly. 

I agree with the result here, but if it was reached based on the premise that XM and Sirius simply don’t compete–rather than on the premise that they compete vigorously and with myriad other competitors in a properly-understood market–then it was wrongly decided.   

UPDATE:  Both Josh and David Fischer point me to the DOJ press release, available here.  The press release does clarify matters.  It seems that the DOJ does recognize competition between providers for new users, but still hangs its hat substantially on the notion that ex post competition is unrealistic in the automotive market (one perhaps wonders why the DOJ didn’t divide the markets by channel of distribution, a la the FTC in Whole Foods.  Not that I’m recommending it).  Here’s a sample:

The need for equipment customized to each network means that in order to switch from XM to Sirius, or vice versa, a subscriber would have to purchase new equipment designed for the other service. In the case of a factory-installed car radio, switching satellite radio providers would have the additional disadvantage of requiring an aftermarket radio that would be less integrated into the vehicle’s systems. Data analyzed by the Division confirmed that subscribers rarely switch between XM and Sirius.

Historically, XM and Sirius engaged in head-to-head competition for the right to distribute their products and services through each car company. As a result of this competitive process, XM and Sirius have provided car manufacturers with subsidies and other payments that indirectly reduce the equipment prices paid by car buyers to obtain a satellite radio. However, XM and Sirius have entered into sole-source contracts with all the major automobile manufacturers that fix the amount of these subsidies and other pertinent terms through 2012 or beyond. Moreover, there was no evidence that competition between XM or Sirius beyond the terms of these contracts would affect customers’ choices of which car to buy. As a result, there is not likely to be significant competition between XM and Sirius for satellite radio equipment and service sold through the car manufacturer channel for many years.

[Meanwhile, in the retail market,] The Division found that evidence developed in the investigation did not support defining a market limited to the two satellite radio firms, and similarly did not establish that the combined firm could profitably sustain an increased price to satellite radio consumers.

According to the DOJ, XM and Sirius have locked in sole-source contracts with all of the major car manufacturers through 2012, effectively ending competition in that market.  I’d say that’s fair enough.  The companies did compete for those contracts, and they can be presumed efficient (as the DOJ suggests).  Remaining competition is largely in retail, where a product market definition limited to satellite radio is unsupported.  Sounds about right to me. 

My only caveat:  I’m sure the allegedly high switching costs in the automotive market will come down substantially (and unexpectedly) as technology develops, introducing further competition.  I’m equally sure that the other satellite radio competitors are already, and will become increasingly, important in the automotive market, as well, further limiting any ability to extract monopoly rents.

Tulane’s annual “Corporate Law Institute” is coming up!  The conference - widely viewed as the must-attend deal conference of the year is April 3 and 4 (only two weeks away).

The roster for this year’s conference reads like a who’s who of the deal world, with a range of Delaware jurists, investment bankers, top lawyers, and Wall Street media on the two days worth of panels.

The conference, which is organized by practitioners (not Tulane folks), was started twenty years ago by former Delaware jurist and Tulane Law alum former Justice Andrew Moore.  (As you corporate law wonks know, Justice Moore wrote several of the big takeover opinions from Delaware in the mid-1980s.  Many in the corporate law world were scandalized when Justice Moore was not reappointed when his term expired, but, based on the takeover opinions he penned, those of us who are cynical about just how political and pro-defendant Delaware tries to be were not surprised.)  Justice Moore will be making an appearance on the 20^th year retrospective panel at the Tulane conference.

The conference should be stupendous, and I hope those of you who are reading this and will be attending the conference will make it your business to introduce yourselves to me.  I will be on the private equity panel on Friday, but I will be attending both days of the conference in full.

The specifics of the conference are here.

I’m a bit late to the party on Jeffrey Rosen’s provocative article in the NY Times Magazine claiming that the Supreme Court is biased in favor of businesses. For readers not familiar with Rosen’s claim, the basic assertion is that:

With their pro-business jurisprudence, the justices may be capturing an emerging spirit of agreement among liberal and conservative elites about the value of free markets.

Eric Posner’s insightful response hits the nail on the head in critiquing Rosen’s characterization for lack of evidence and exposing Rosen’s implicit assumption that populist jurisprudence is the “unbiased” baseline. I want to focus in the role of the Roberts Court antitrust cases in Rosen’s claim. Rosen cites to these cases as evidence in favor of his bias claim, noting the significant increase in antitrust activity in the Court in recent years and emphasizing the fact that “the Roberts Court has heard seven [cases] in its first two terms - and all of them were decided in favor of the corporate defendants.”

So what are we to make out of these cases? Are the Roberts Court cases really pro-business? Rosen’s “pro-business bias” claim is analytically identical to Erwin Chemerinsky’s take on the Supreme Court cases that I criticized here awhile back (Chemerinsky concluded that the Supreme Court’s antitrust decisions favored “businesses over consumers”). It is also identically incorrect.

Posner gives one excellent reason in his response when he notes that 6 out of the 7 Roberts Court cases involve businesses as both plaintiffs and defendant. Only Twombly involved consumer plaintiffs (and Credit Suisse involved a mixed class of plaintiffs including corporate investors). As Posner notes, it is a bit of a reach to credibly claim “pro-business bias” on this track record where a corporate plaintiff loses in the majority of the cases.

But there is another reason that this “pro-business bias” argument should be dismissed as incorrect with respect to the antitrust cases despite the superficial and soundbyte style argument that a winning streak for defendants is a sufficient condition for anti-consumer bias. I’ve argued elsewhere at length that the Roberts Court’s antitrust jurisprudence can be characterized as embracing the Chicago School tradition of antitrust analysis with its emphasis on theoretical rigor, empirical evidence, and sensitivity to error costs. To the extent that this is consistent with the view that the Roberts Court’s antitrust cases are increasingly “pro-market,” there is an important difference between that statement and the leap to “biased in favor of businesses over consumers!”

The 5-4 decision in to overrule Dr. Miles’ per se prohibition against minimum resale price maintenance in Leegin provides an illustration of that difference in practice. Is Leegin pro-business? Quite obviously, we would need to know something about whether minimum RPM is good or bad for consumers before we concluded that lifting the per se prohibition was a good or bad thing. A Supreme Court interested in consumer welfare analysis (what antitrust does) would be interested in the competitive effects of minimum RPM in order to address the underlying issue: are consumers better or worse off when we allow the practice? A Supreme Court biased in favor of business would have no need at all for that sort of inquiry. But Justice Kennedy’s opinion on behalf of the majority relies extensively on economic theory and empirical evidence that minimum resale price maintenance made consumers better off! Now, one might think that the Court got it wrong, misunderstands the evidence, and that RPM actually harms consumers. For the record, I disagree and believe Leegin was correctly decided. But to argue that the Court got there by favoring business over consumers is not accurate, and obvious from reading the opinion.

What about Twombly? The one case which involves a consumer plaintiff. Is Twombly biased in favor of businesses? It certainly makes it more difficult for plaintiffs to survive a motion to dismiss in a Section 1 case. But is that anti-consumer? Again, only under a superficial analysis of the reasoning in that case. Specifically, the Court is concerned that abuse of the antitrust laws through discovery and frivolous claims exposes firms to the risk of false positives and may chill pro-competitive conduct — which is bad for consumers. One might disagree with these concerns, or believe that the Court misunderstands their magnitude or impact on consumers. But the Court explicitly motivates its analysis with concern about the social costs of abuses of private antitrust enforcement which are passed on to consumers. Similar concerns motivated the Court’s analysis in Credit Suisse. To argue that this conclusion comes from some sort of pro-business bias is a stretch.

We could do this with the rest of the cases. There is clearly a shift in antitrust analysis in the Supreme Court both in terms of activity level and, to a lesser extent, the analytical framework employed. The adoption of the Chicago School of antitrust analysis principles is not properly viewed as a pro-business bias. In fact, it was contributions from that movement in economics that demonstrated why some business practices previously thought to be inefficient actually improved consumer welfare. Subsequent empirical evidence has been overwhelmingly consistent with this approach. I don’t have enough expertise in the other areas of law that Rosen covers to say something about the general claim, though I suspect Posner’s characterization is correct. With respect to the antitrust cases, the Roberts Court decisions have been thoughtful and mindful of the ultimate goal of antitrust: consumer welfare. The conclusion that these cases are biased must rely on some implicit assumption that there is an “unbiased” baseline approach to these cases that does not involve consumer welfare analysis. At least for the past 30 years, and to the benefit of consumers, modern antitrust analysis has rejected alternative approaches that favor small businesses (”small dealers and worthy men”) or non-economic concerns.

Todd Zywicki and Maxwell Stearns have a draft of their new textbook, “Public Choice Concepts and Applications in the Law,” available for review for profs that are interested in teaching with the manuscript this Fall 2008 or Spring 2009 term (the book is due to be published in 2009).  The book is designed for law profs along with “teachers of economics, political science, and public policy courses as well … and to be taught as either a follow-on to a traditional law and economics course or as a substitute for a traditional law and economics course.”  Zywicki & Stearns description of the project and invitation for those interested in early adoption to view the current manuscript is below the fold.

(more…)

• The new Global Competition Policy online magazine contains some insightful commentary on the Google/ Doubleclick clearance, critical loss analysis in Whole Foods (from Kevin Murphy and Robert Topel) and more generally (from Greg Werden), as well as competing reactions to the Intel antitrust allegations …
• The Supreme Court did not grant cert in Microsoft v. Novell, letting stand a lower court decision which allowed Novell to sue Microsoft despite not competing in the operating system market
• In textbook news, the Third Edition of the Gavil, Kovacic and Baker’s Antitrust Law in Perspective is estimated to be available by May 22, 2008; Einer Elhauge has also just released his own new textbook on U.S. Antitrust Law and Economics with Foundation Press (reportedly available by April 22).
• Chairman Majoras’ opening remarks at the FTC/DOJ program on international technical assistance