THE FTC ABANDONS (THE RULE OF) REASON

On November 10, 2022, the Federal Trade Commission (FTC) issued a policy statement (the “Policy Statement”) radically expanding the FTC’s interpretation of prohibited “unfair methods of competition” under Section 5 of the FTC Act. According to the Policy Statement, in determining whether something is unfair, the FTC will consider (1) whether the conduct is “coercive, exploitative, collusive, abusive, deceptive, predatory, or involve[s] the use of economic power of a similar nature” and (2) whether the conduct impairs competition. Notably, the FTC is abandoning the longstanding “rule of reason” previously employed by the FTC and by courts in antitrust cases. Instead, the Policy Statement states that the FTC may bring Section 5 cases without alleging a relevant product market and may not allow companies to justify allegedly unfair conduct with procompetitive or business justifications. Although this interpretation will no doubt be tested in the courts in the coming years, the Policy Statement creates significant uncertainty for companies now, both in their day-to-day activities and in the M&A context.

Section 5 and the 2015 Statement

Congress enacted the FTC Act in 1914. Section 5 of the FTC Act prohibits “[u]nfair methods of competition in or affecting commerce.”^[1] In large part, Congress designed Section 5 to supplement the Sherman and Clayton Acts.^[2] Although the FTC often alleges a Section 5 violation with violations of the Sherman and/or Clayton Acts, it has rarely brought standalone actions enforcing Section 5. As a result, there has been little jurisprudence interpreting Section 5, and the Supreme Court has never identified Section 5’s outer bounds (or even the standard for identifying a violation).

“The standard of ‘unfairness’ under the FTC Act is, by necessity, an elusive one, encompassing not only practices that violate the Sherman Act and the other antitrust laws, but also practices that the [FTC] determines are against public policy for other reasons.”^[3] Although the Supreme Court has acknowledged that Section 5 is “a broad delegation of power” leaving the “development of the term ‘unfair’ to the [FTC],”^[4] the Supreme Court’s willingness to defer to the FTC’s determination of what is “unfair” has waned.^[5]

For decades, in determining whether something was an unfair method of competition, the FTC used a framework similar to that employed in Sherman Act and Clayton Act cases. Specifically, (1) the FTC took the view that Section 5’s goal was to maximize consumer welfare, (2) would usually only bring a standalone challenge if the Sherman and Clayton Acts were insufficient, and (3) would evaluate “unfairness” by considering whether the conduct was likely to harm the competitive process, accounting for any offsetting procompetitive effects or business justifications, consistent with the longstanding rule-of-reason framework.^[6] This approach was codified in a 2015 bipartisan policy statement (the “2015 Statement”).

Last year, the FTC rescinded the 2015 Statement. And on November 10, the FTC issued the Policy Statement, radically departing from its prior practice, untethering Section 5 from the rule of reason, and raising more questions than it answers. The Policy Statement takes an expansive view of Section 5’s scope but provides little concrete guidance as to what is “unfair.”^[7]

The Policy Statement

The Policy Statement offers the following framework and guidance for determining whether something is an unfair method of competition.^[8]

Method of Competition

Section 5 only applies to methods of competition, meaning that it only prohibits conduct, not conditions.^[9] For example, anticompetitive conditions (high barriers to entry, concentrated market share, etc.) that are outside of a firm’s control would not fall within the FTC’s view of Section 5. Moreover, the conduct “must implicate competition,” although it “can be indirect.”^[10] For example, indirect competitive conduct like the “misuse of regulatory processes” (the patent process, for example) could qualify if it impedes competition.^[11]

Unfair

The conduct must be “unfair.”^[12] Competition on the merits, which includes superior products, superior business acumen, truthful advertising, innovation, or better employment terms, is not considered unfair.^[13] In determining whether something is not “on the merits” and thus “unfair,” the FTC will consider two key factors on “a sliding scale,” meaning that a strong showing on one factor excuses a weak showing on the other.

First, the FTC will consider whether the conduct is “coercive, exploitative, collusive, abusive, deceptive, predatory, or involve[s] the use of economic power of a similar nature.” Notably, this is not a quantitative evaluation but a qualitative one. For this factor, it is not just about whether conduct increases prices, for example, but whether that conduct is unethical, unreasonable, or wrong.

Second, the FTC will consider whether the conduct impairs competition by, for example, impairing the opportunities of market participants, reducing competition, limiting choice, or otherwise harming consumers.^[14] The FTC takes the position that no actual harm to competition is required, so long as the conduct “has a tendency to generate negative consequences.”^[15] Its “focus” is “on stopping unfair methods of competition in their incipiency.”^[16] Notably, the FTC does not believe that a market definition or a showing of market power is required to demonstrate an impairment of competition.

Further, the FTC will not only consider the impact of the respondent’s conduct or one specific form of conduct. The second factor may be met “when the conduct is examined in the aggregate along with the conduct of others engaging in the same or similar conduct” or “when the conduct is examined as part of the cumulative effect of a variety of different practices by the respondent.”^[17]

Justifications

Typically, in antitrust cases, courts take care to balance anticompetitive effects against procompetitive justifications. And for good reason. “[M]istaken condemnations of legitimate business arrangements are especially costly, because they chill the very procompetitive conduct the antitrust laws are designed to protect.”^[18]

The Policy Statement takes the opposite tack, suggesting that it may be impossible to justify conduct that, prima facie, violates Section 5. If the FTC does consider a company’s justification:

• It is the company’s burden to demonstrate that the justification “is legally cognizable, non-pretextual, and that any restriction used to bring about the benefit is narrowly tailored to limit any adverse impact on competitive conditions”;^[19]
• the company must demonstrate that the asserted benefits “are of the kind that courts have recognized as cognizable in standalone Section 5 cases”;^[20] and
• the FTC will not consider benefits outside of the market where the harm occurs.^[21]

Examples of Violative Conduct

The Policy Statement offers a lengthy list of conduct that may violate Section 5. Some notable instances include: practices that facilitate tacit coordination, parallel exclusionary conduct that may cause aggregate harm, fraudulent and inequitable practices that undermine the standard-setting process or that interfere with the Patent Office, knowingly inducing and receiving disproportionate promotional allowances, loyalty rebates (and similar practices) that entrench market power, acquiring a nascent competitor, utilizing technological incompatibilities to harm an adjacent market, interlocking directorates not strictly prohibited by the Clayton Act,^[22] commercial bribery that creates or maintains market power, false or deceptive advertising that creates or maintains market power, and refusals to deal that create or maintain market power.

Process and Penalties

The FTC may launch administrative proceedings against a company if it believes that it has violated Section 5.^[23],[24] If it determines that a company has violated Section 5, the FTC can issue a cease-and-desist order,^[25] which may be appealed to any court of appeals “where the method of competition . . . was used” or where the company “resides or carries on business.”^[26] Judicial review is somewhat limited: courts give some deference to the FTC’s determination that something is an unfair method of competition and will only overturn the FTC’s factual findings if they are not supported by substantial evidence.^[27]

Generally, in enforcing Section 5, the FTC is limited to injunctive relief preventing the challenged conduct.^[28] And unlike the Sherman and Clayton Acts, there is no private cause of action for a Section 5 violation.^[29] But given the overlap between Section 5 and the Sherman and Clayton Acts, there is some potential for so-called “follow-on” litigation by private entities, with the possibility of treble damages, following a finding of Section 5 liability. Moreover, even without a finding of liability, the FTC’s investigation into a potential Section 5 violation can itself be extremely lengthy and burdensome.

What’s Next?

At the end of the day, the FTC’s Policy Statement is just that. Whether something qualifies as an “unfair method of competition” violating Section 5 is ultimately a question for the federal courts. And there is good reason to question whether federal courts would agree with the FTC’s broad view of Section 5 liability.

• Courts have historically been suspicious of attempts by the FTC to extend Section 5 liability without a clear framework or methodology.^[30] They have similarly rejected theories of Section 5 liability that would allow the FTC to enforce non-economic societal or political preferences.^[31]
• Courts have previously rejected attempts to extend Section 5 liability to one company based on the reaction of other market participants or on the aggregation of a type of conduct.^[32]
• Even though, as discussed above, Section 5’s scope is conceptually distinct from the Sherman and Clayton Act, courts have often rejected attempts to hold conduct liable under Section 5 that would fail under Sherman Act and Clayton Act caselaw.^[33]
• Federal courts have been increasingly suspicious of attempts by agencies to expand regulatory authority through revised interpretations of federal law.^[34]

Still, the Policy Statement offers important insight into the FTC’s current view of Section 5 and signals that the FTC intends to pursue aggressive enforcement actions on novel legal theories. Even if those enforcement actions fall short of liability, they could involve lengthy and expensive investigations.

Special thanks to associate Tina Asgharian (New York–Antitrust) who co-authored this publication.