August 2024 ICLEAR Update

ICLE Nonresident Scholar Joanna Shepherd was a guest on WEKU’s Democracy Optimist podcast to discuss her research on elected judges and the role of money in judicial campaigns. Audio of the full episode is embedded below.

Abstract

Understanding how institutions, technology and social welfare coevolve is essential to understanding economic and social development, and the evolution of privacy alongside institutions and technology in the modern era sheds valuable light on this question. Privacy has both private individual value and public social value, even as privacy rights tradeoff directly with the ability of the government to enforce the law. We deem this inherent defect in the government’s incentives to protect privacy the “institutional privacy dilemma,” a defect which results in a greater role for technological innovation and individual choice to preserve rights to privacy alongside the public institutions that both protect and infringe it. In the digital age, technological change has led to greater private use of encryption to preserve individuals and organizations’ rights to privacy. Yet, this technology itself poses a challenge for law enforcement, for encryption shields those with innocent and criminal motives alike. Unsurprisingly then, governments have sought to weaken or eliminate encryption in the face of the privacy dilemma, with an emerging set of technological solutions preserving private actors’ rights to a measure of privacy while applying zero-knowledge proofs to simultaneously satisfy legitimate enforcement objectives. Our case study of applications of zero-knowledge proofs and privacy institutions illuminates how a coevolving blend of polycentric forces governs social welfare in practice and emphasizes how individual demand for rights the government is especially likely to infringe plays an essential governance role.

Abstract

A meme is a useful cognitive device: it compresses complex information into a simple structure for easy transmission from person to person. But compression implies loss of detail and nuance. To put it another way, memes can be a substitute for careful inquiry. And, of course, even as they glide fluidly from mind to mind, memes can be flat-out wrong. In the field of antitrust, the most significant and most frequently encountered memes give credit to antitrust oversight—what the New Deal antitrust czar Thurman Arnold famously called “the policeman at the elbow”—for ensuring that large firms did not stand in the way of innovation. Careful historical inquiry suggests, by contrast, that most of these memes far overstate the positive value of antitrust scrutiny and far understate the importance of dynamic competition as the spur to innovation. History also suggests that even if antitrust scrutiny can be a good cop, it can also be a bad cop. In many cases, antitrust scrutiny has helped slow the rate of innovative activity and alter its direction in ways that were often the opposite of what was intended.

Abstract

Abstract

The impetus for change in monopoly electric systems has ebbed and flowed for over three decades. Over the past 15 years the interest in and ability to update electricity system technologies has grown, due to the combination of changing policy objectives and widespread digital innovation. Whether you call it smart grid or grid modernization, digital technologies by now have long had the potential to transform electric systems, improving their operations, reducing waste and idleness, and (but I repeat myself) having more market-based systems. Separate but complementary improvements in the performance and production costs of distributed energy resources like solar PV, electric vehicles, and battery storage, along with the policy focus on decarbonization, have amplified interest in and work on digitalization. Digitalization has reduced transaction costs and created unforeseeable types and amounts of value in the rest of the economy. Shouldn’t it do so too in electricity?

Abstract

This study investigates the evolution of economic analysis in antitrust litigation using an original dataset encompassing all decided antitrust cases since the enactment of the Sherman Act in 1890. Our analysis reveals three distinct breaks in the frequency of economists mentioned in antitrust cases: 1974, 1994, and 2007. Furthermore, we observe substantial fluctuations in the success rates of plaintiffs across various stages of litigation. Additionally, the study finds that the underlying statutory basis of cases involving economists has shifted over time, with a notable increase in Sherman Act cases and a corresponding decrease in Clayton Act and combined Clayton-Sherman Act cases.

When one thinks of America’s war in the 1960s during the administration of President Lyndon Johnson, the Vietnam War comes to mind. The American government spent about $175 billion and the lives of about 58,000 men in a futile attempt to stop the communist takeover of South Vietnam. But as costly as this war was, it pales in comparison with the other war President Johnson, and all subsequent presidents have fought in vain—the “war on poverty.” In an address to Congress in January 1964, President Johnson declared an “unconditional war on poverty.” The effort has been almost entirely futile and has cost the American taxpayers more than $30 trillion. This is more than three times the cost of all military wars from the American Revolution to the War on Terror.

Read the full piece here.

Abstract

The use of antitrust in the context of food is problematic because it so clearly violates the Consumer Welfare Standard as prescribed by the courts. Ultimately, antitrust rhetoric promoting ad nauseam enforcement will not improve consumer welfare. Advancing consumer welfare in the food industry must mean prioritizing lower food prices over some arbitrary threshold of market competition or protecting small farms. Courts can and should begin distinguishing these goals immediately.

Read at SSRN.

Abstract

This Article will evaluate the consequences of the General Data Protection Regulation (“GDPR”) implemented by the European Union (“EU”) in 2018. Despite its aim to bolster user privacy, empirical evidence from thirty-one studies suggests a nuanced impact on market dynamics. While GDPR modestly enhanced user data protection, it also triggered adverse effects, including diminished startup activity, innovation, and increased market concentration. Further, this Article will uncover a complex narrative where gains in privacy are offset by compliance costs disproportionately affecting smaller firms. This Article will also highlight the challenges of regulating highly innovative markets, which is particularly important given subsequent EU regulations, such as the Digital Markets Act (“DMA”) and Digital Services Act (“DSA”). As other jurisdictions consider similar privacy regulations, the GDPR experience is a cautionary tale.

Read at SSRN.

ICLE Academic Affiliate Joshua R. Hendrickson was quoted by WJTV News 12 in a story about proposed changes to Mississippi’s system of taxation. You can read the full piece here.

Dr. Joshua Hendrickson, chair of the Department of Economics at the University of Mississippi, said the state’s current tax structure is an obstacle for many.

“We sort of have the worst of all worlds. You earn a dollar and that dollar gets taxed by the income tax. And then if you spend that dollar, it gets taxed again by the sales tax. If you save that dollar and you earn any interest on that dollar, that that interest gets taxed on the income tax. The state is going to have to think about how to streamline it’s tax system,” said Hendrickson.

…“I’m not sure that the state will be able to completely eliminate the income tax without replacing some of that revenue. Just trying to get there without increasing any other taxes seems very, very unlikely,” said Hendrickson.

ICLE Academic Affiliate Adam Mossoff was quoted by IPWatchdog from his U.S. Senate Judiciary Committee testimony on the role of patents in the prescription-drug prices. You can read the full piece here.

Professor Adam Mossoff of the Antonin Scalia Law School, George Mason University and Jocelyn Ulrich, Vice President, Policy & Research for PhRMA, were the two pro-patent witnesses on the panel. William Feldman, Associate Physician, Division of Pulmonary and Critical Care Medicine at Brigham and Women’s Hospital; Professor Arti Rai, Elvin R. Latty Distinguished Professor of Law at Duke Law; and David Mitchell, President and Founder of Patients for Affordable Drugs, all argued from different perspectives that patent abuses are the key reason Americans pay more than four times those in other economically comparable countries for the same drugs.

…Professor Mossoff, on the other hand, said that “policy-driven arguments about patents have sown confusion.” The problem, Mossoff said, is that the causes of U.S. drug pricing problems “are complex and multidimensional yet we’ve reduced it to a single cause – patents.” Mossoff pointed to two federal laws that are presently being misused by those seeking to assert price controls—the Bayh-Dole Act  and Section 1498—and said that imposing march-in rights for pricing under Bayh-Dole or forcing compulsory licenses under Section 1498 would “turn the law on its head” and would also be ineffective.

Mossoff also explained that the statistics cited by Durbin on NIH’s role in the R&D process are misleading. As of 2018, Mossoff said, private companies invested $129 billion in private R&D funding, “which dwarfs the $40 billion or so by NIH.” One 2021 study showed that the 23,200 grants by NIH in the year 2000 were linked to just 18 FDA approved meds by 2020. “NIH funds very far upstream initial research and then once the university researchers figure out it’s important, they get a patent, the university licenses it to a biotech company… and that’s what accounts for the $2.6 billion on average that goes into drug development and ultimately leads to an FDA-approved drug in the marketplace,” Mossoff said.

…“I’ve been here for 10 years and the substance of this hearing is not materially different than the substance of hearings that I had in my first Congress here,” Tillis said. He alluded to his thwarted efforts to obtain information on I-MAK’s data, which Mossoff and others have called out as being flawed, and said the Committee has failed to make progress and may have even taken steps backward with “well-intentioned provisions in the [IRA]” because “we at least know we’re reducing incentives to invest and take risk.”

 

 

ICLE Academic Affiliates Jonathan M. Barnett and Luke Froeb were quoted by Variety in a story about antitrust concerns that could be raised by growing sentiment in Hollywood that studios need to merge. You can read the full piece here.

“There are certain portions of the antitrust community who are of the view that certain elements of antitrust law over almost half a century have gone in the wrong direction,” says Jonathan Barnett, a professor at USC Gould School of Law. “The focus has been in particular on the rise of digital platforms and the accompanying level of concentration that you now observe in those markets.”

…Luke Froeb, Vanderbilt University professor and former chief economist for the Justice Department’s antitrust division, is critical of the Biden-era approach.

“They’ve stepped away from 50 years of case law that made things reasonably clear [for companies],” Froeb says. “They’re saying, ‘Hey, we’re going back to the ’60s, when we thought ‘Big is bad.’”

…“Deal risk is now elevated,” USC’s Barnett says. “The agencies are challenging deals that we wouldn’t have expected to be challenged under conventional antitrust doctrines. The agencies are demanding more information and more evidence of efficiencies in merger reviews. That all adds more costs and more risk of rejection.”

In 2017, the Federal Trade Commission and two state attorneys general took legal action to stop the merger of FanDuel and DraftKings, two corporate behemoths in the fantasy sports market. The FTC argued that the proposed merger would give one company control of nearly 95% of the market. “This merger would deprive customers of the substantial benefits of direct competition between DraftKings and FanDuel,” said Tad Lipsky, then the acting director of the FTC’s Bureau of Competition. At the end of the day, the FTC’s opposition stopped the merger in its tracks, but recent actions by the two companies raise questions as to whether the FTC should take another look at marketplace concentration—and its implications—in the fantasy sports industry.

Read the full piece here.

The exponential growth of data centers, driven by the burgeoning demand for cloud services, AI computations, and big data analytics, has increased electricity consumption significantly. In the first two posts of this series, I discussed the increasing data center electricity use, its implications for the electric grid, and how those implications will differ over time due to both demand and supply elasticity.

Read the full piece here.

A growing movement to break from Republican orthodoxies to carve out a distinctly pro-worker platform has gained traction over the last few years. This idea—that the GOP ought to assert itself more fully as the “pro-worker party”—was solidified when Donald Trump chose J.D. Vance as his running mate and invited the president of the Teamsters union to speak at the Republican convention.

Read the full piece here.

“Antitrust damage is pretty strong medicine,” said John Lopatka, a law professor at Pennsylvania State University and an antitrust scholar. “Each one of these schools is making a calculation about how much is it going to cost to litigate this case. What’s the potential loss they are facing and how much do they have to pay to get out of it.”

Read the full article here.

ICLE Academic Affiliate Josh Hendrickson was quoted in the New York Times about Vice President Kamala Harris’ price controls proposal. You can read the full piece here.

“If prices are rising on average over time and profit margins expand, that might look like price gouging, but it’s actually indicative of a broad increase in demand,” said Joshua Hendrickson, an economist at the University of Mississippi who has written skeptically of claims that corporate behavior is driving prices higher. “Such broad increases tend to be the result of expansionary monetary or fiscal policy — or both.”

Executive Summary

Capital One’s proposed acquisition of Discover Financial Services has the potential to transform competition and consumer welfare in the retail banking market. Through synergies and cost savings, the new entity would compete more vigorously with other banks and payment networks. Not only will this better serve the public in general, by bringing together the firms’ traditional expertise in the development of innovative banking and credit card markets aimed at middle-income consumers, it would also likely expand financial inclusion among underserved communities. And while some critics have expressed concerns that the merger could harm competition, those concerns are speculative and ungrounded in well-established principles of antitrust analysis. Major points to consider include that:

• Discover’s credit card network is the fourth-largest in the United States, accounting for only about 4% of payment volume. Discover has languished at that figure for two decades, trailing far behind Visa, MasterCard, and American Express. For years, many commentators and government officials have expressed concern about a perceived lack of competition in the credit card network market, going so far as to refer to a Visa and MasterCard “duopoly” and calling for legislation that they believe would increase competition in the credit card industry. Capital One may be able to use its innovative culture and marketing savvy to leverage Discover’s card network and allow it to compete more successfully.
• By switching its debit cards to Discover’s payment networks, Capital One might offer more attractive products to depositors. In particular, it could expand access to free checking accounts with no minimum balance requirements to a wider range of low-income consumers. And it could offer debit cards with cashback to lower-income consumers who would not qualify for credit cards. The benefits for this important underserved community could be enormous.
• In combination, Capital One and Discover would be the sixth-largest bank by assets, although it would hold only 3% of all domestic assets, a trivial amount compared to industry behemoths such as JPMorgan Chase, Citibank, and Bank of America. Moreover, cost savings and other synergies could make it a more effective competitor in the large national-bank market, driving improvements among other, similar-sized banks that together serve large segments of the U.S. population.
• The combined Capital One-Discover would become the third-largest credit card issuer by purchaser volume, after JPMorgan Chase and American Express. Given that there are thousands of credit card issuing banks in the United States and the largest issuers only have a modest percentage of all volume any potential countervailing adverse effect on competition would likely be minor if noticeable at all. As with its banking operations, its scale and innovative approach could drive improvements both directly for its customers and indirectly for customers of other banks, who would be driven to provide competitive offerings.
• By increasing network traffic, purchasing volume, and revenue dramatically; enabling a seamless integration of customer and merchant data generated by network activity and issuer processing; and allowing increased financial investments in security, the merger would enable the combined company to increase consumer data security. The ability to capture and analyze more data on more customers may also permit the larger and more competitive company to develop and offer new innovative products designed for more fine-grained customer groups.

I.        Introduction

On Feb. 18, 2024, Capital One Financial Corp. announced that it had entered into an agreement to acquire Discover Financial Services in an all-stock transaction valued at $35.3 billion.[1] Before the transaction can be finalized, however, it must be approved by both the U.S. Office of Comptroller of the Currency (OCC) and the Federal Reserve. The two agencies held a July 19, 2024, public meeting on the proposed merger, and have extended public comments on the deal until July 24, 2024.[2]

The proposed acquisition has engendered substantial public and political scrutiny from critics who claim it would have anticompetitive effects. For example, a number of Democratic members of Congress,[3] as well as members of the House Financial Services Committee, specifically,[4] and one Republican senator,[5] have written to the regulators responsible for reviewing the merger to urge that it be blocked on that basis.

These criticisms of the proposed merger, however, are confused. To be sure, the combined bank would be larger than either of the two companies standing alone. Yet its size still would pale in comparison to firms such as JPMorgan Chase, Citibank, and other retail bank companies.

More importantly, reflexive “big is bad” arguments overlook the pro­-competitive benefits of the merger to consumers and the banking industry. By combining Capital One’s innovative style and marketing dynamism with Discover’s existing network infrastructure and widespread acceptance, the new company could provide a viable new competitor to both existing large banks and to the payment-card-network space currently dominated by Visa and MasterCard. The result should be enhanced competition across the board, but particularly in the market for payment card networks, about which many of these same critics of this merger have complained lacks adequate competition due to the supposed Visa and MasterCard “duopoly.” Rather than trying to artificially impose a counterproductive scheme of competition on that market through heavy-handed government regulation, such as the Credit Card Competition Act,[6] the merger would do exactly what sponsors of that act claim to desire: foster more robust competition in the payment-card-network space.

This white paper uses the tools of law & economics to evaluate the likely effects of the merger, with a particular focus on two of the key criteria the agencies are required to evaluate: (1) the convenience and needs of the communities to be served by the combined organization and (2) competition in the relevant markets.[7]

The primary communities served by both Capital One and Discover comprise lower-risk low-income and middle-income consumers who have been underserved by other large financial firms. The merged company will presumably continue to seek to attract and maintain such consumers, while also potentially expanding into other market segments. Indeed, the new company may better serve such communities. This could be achieved through synergies that would enable it to invest in innovation and thereby offer better products at a lower cost. In addition, the combined firm plans to issue debit cards on its own proprietary network, enabling it to offer enhanced products to consumers (because it will not be subject to the price controls and routing requirements imposed on debit card issuers subject to the Durbin amendment and related regulations). For example, the company should be better able to market no-fee, no-minimum-balance bank accounts to underserved low- and middle-income consumers. Furthermore, by combining some credit card operations, the new entity should benefit from scale economies and the ability to cross-market products.

On the competition side, the relevant markets are, broadly, banking (deposits and loans) and payments (card issuance and acceptance, and network facilitation). With respect to the former, the combined company would be the sixth-largest bank in the United States by assets, and roughly one-quarter the size of JPMorgan Chase (the nation’s largest bank).[8]If the relevant market is large banks with national reach, the merger will plausibly result in an increase in competition, as the new entity will have greater scope and scale, enabling it to compete more effectively with other large national banks.

Regarding credit card issuance: recent figures suggest that Capital One and Discover combined would be the largest holder of credit card debt in the nation, accounting for nearly 22% of outstanding credit card loans by dollar amount.[9]Even so, and contrary to claims made by some critics of the proposed merger,[10] there is no reason to believe this would harm competition. The increase in market share for credit card debt would not trigger thresholds inviting close scrutiny under federal bank-merger guidelines, or the 2023 Federal Trade Commission (FTC) and U.S. Justice Department (DOJ) merger guidelines.[11] Moreover, as the company notes in its filing with the regulators:

Vertically integrating with Discover’s payments networks will add scale to these credit and debit networks—which respective market shares are in long-term decline— making the networks less costly to operate on a marginal basis and more attractive to consumers and merchants. The combination will also allow Capital One to lower its transaction-related costs and to reinvest those dollars in improved banking products and services, including investments into the payments networks to reduce fraud, improve dispute resolution processes, and lessen information sharing friction to the benefit of consumers and merchants. These network investments will allow Capital One to further scale the networks, improve the actual and perceived acceptance of the networks, and create a credible alternative to the Visa, Mastercard, and Amex payments networks, which dominate the industry today.[12]

Critics of the merger, by contrast, have failed to articulate any tangible harms to competition or consumers from the merger beyond reflexive “big is bad” rhetoric.

From a law & economics perspective, the merger’s potential to create a stronger fourth network aligns with the theory that increased competition can lead to greater market efficiency and consumer welfare. A more competitive network landscape could pressure all players to improve their offerings, potentially resulting in lower fees, better security features, and more innovative payment solutions. This outcome would be consistent with the goals of antitrust law, which seeks to promote competition, rather than protect individual competitors.

In sum, the evidence strongly suggests that this merger would meet the needs and convenience of the communities served by the combined organization and would be pro-competitive in all relevant markets.

II.      Background

The prospective acquisition of Discover by Capital One would bring together Capital One’s savvy marketing and innovation advantages with Discover’s legacy advantage as a payment-card processing network, thereby creating a new viable competitor to both existing banking giants (such as JPMorgan Chase and Citibank) as well as existing payment networks (Visa, MasterCard, and Amex). At the same time, however, the combined entity will remain a fraction of the size of these incumbent banks and networks. The end result should benefit competition and consumers substantially, especially in the network issuing space.

A.      Discover

Discover Financial Services originated in 1985 as a subsidiary of Sears, Roebuck, and Co., arising as a general-purpose spinoff of the legendary Sears credit card program. In 1985, Sears was the largest consumer-lending operation in America, with 60 million cardholders and customer receivables of more than $12 billion.[13] The ubiquity of the Sears credit card owed in large part to the department store’s towering presence in the nation’s retail landscape, and particularly the company’s long-established Sears catalog. Sears had 796 retail stores and more than 3,000 branch offices of its subsidiaries: Dean Witter Financial Services, Allstate Insurance, Coldwell Banker real estate, and Sears Saving Bank.[14] The launch of the general-purpose Discover credit card was part of a larger push at the time by Sears into the consumer retail financial services space, including bank accounts, ATMs, and low-cost retirement brokerage accounts offered by Sears’ Dean Witter Reynolds Inc. brokerage subsidiary.[15] The card was issued through Greenwood Trust Co. bank, which was owned by Sears. Sears was able to capitalize on its relationship with those millions of established Sears credit card customers to launch a new general-purpose card to rival Visa and Mastercard.

The Discover Card’s launch illustrates the logic of two-sided payment card markets and the need to attract both consumers and merchants to the platform.[16] Because of Sears’s existing relationships with 60 million cardholders, Discover likewise found it relatively easy to attract cardholders. The company, however, faced greater difficulty in persuading merchants to take up the card, in part because merchants were reluctant to accept a card affiliated with a major retailing rival (a difficulty further compounded by the fact that the original card face featured an image of the Sears Tower). To induce merchant acceptance, Discover offered a lower merchant discount rate than Visa and MasterCard-branded cards.[17] Today, Discover’s average merchant discount rate remains below that of Visa, MasterCard, and American Express.[18]

To encourage consumers to use the card, Discover’s initial strategy was to differentiate itself by offering a card with no annual fee and a cashback-rewards program for purchases (including quarterly “bonus categories”), both of which were novel and innovative concepts at the time. This helped to attract consumers and carve out a niche in the competitive credit card market.[19] Because of Sears’ massive network of retail stores and affiliates, Discover didn’t need to establish a separate system of bank branches to service customers, a distinctive characteristic that remains the case today (although, today, it is all online). The card was introduced with a 1986 Super Bowl commercial.[20]

One of Discover’s key innovations was its approach to the payment network. Like American Express and Diners Club (at the time), but unlike most other issuers, Discover chose to operate a vertically integrated, “three-party” model, acting as card issuer, acquirer, and payment network.[21] This structure enabled Discover to offer merchants lower fees relative to other acquirers, which helped in building acceptance so that it could compete more effectively with “four-party” cards issued on the Visa and Mastercard networks.[22]

In 1993, Sears spun off Dean Witter into a new company and Discover became part of Dean Witter. In 1997, Dean Witter merged with Morgan Stanley and later rebranded itself as Discover Financial Services Inc. In 2007, Discover Financial Services became an independent company. In 2004, Diners Club (then owned by Citigroup) signed an agreement with Mastercard to provide acceptance in the United States and Canada, making it a four-party card issuer in these markets—and leaving Discover and American Express as the only three-party issuers in the United States.[23] In 2008, Discover purchased Diners Club International from Citigroup, giving it an international payment network, albeit one that today has only a tiny share of transactions. (The U.S. and Canadian franchises of Diners Club were not included in the deal, and were sold by Citigroup the following year to BMO International.)[24]

Consistent with its original plan to evolve into a full-service retail banking establishment, in the late 1990s and early 2000s, Discover expanded its product line beyond credit cards. It ventured into personal loans, student loans, and savings accounts, leveraging its brand recognition and customer relationships to compete in broader financial services. In 2005, Discover acquired the Pulse electronic funds transfer (EFT) network, which provides single-message (PIN) ATM and debit payments for around 4,500 smaller banks.[25]

Despite its early distinction as a market innovator, over time, Discover has grown somewhat stagnant. In terms of credit card market share by purchase volume, Discover has been stuck at approximately 4% to 5% of the U.S. market for almost 20 years and has a negligible global presence.[26] While Discover has a slightly larger number of credit cards in circulation than American Express, Amex’s market share by purchase volume is roughly five times that of Discover.[27] As a network competitor, therefore, Discover has neither the large cardholder base of Visa and MasterCard nor Amex’s highly coveted high-spend customer base. As one news report summarized Capital One’s arguments in support of the deal, “Discover’s network has ceded market share over the past decade and Capital One, as a much bigger bank, can provide the additional scale and volume Discover needs to be competitive.”[28]

B.      Capital One

Capital One Financial Corp. emerged in the early 1990s as a spin-off from Signet Bank, under the leadership of Richard Fairbank and Nigel Morris.[29] Their vision was to revolutionize the credit card industry by applying data analytics and information technology to consumer finance.[30] This approach, often referred to as “information-based strategy,” allowed Capital One to tailor its offerings to specific customer segments, a novel concept at the time.[31]

The company’s key innovation was its use of data-mining techniques to identify and target potential customers with personalized credit card offers.[32] This strategy allowed Capital One to extend credit to a broader range of consumers, including those who might have been overlooked or rejected by traditional banks.[33] By using sophisticated risk-assessment models, they could offer competitive rates to customers across various credit profiles, effectively disrupting the one-size-fits-all approach prevalent in the industry.[34] Writing in the Financial Times, former Federal Deposit Insurance Corp. (FDIC) Chair Sheila Bair noted:

I suspect Capital One’s subprime market share is relatively substantial because other banks simply have less (or no) interest in serving subprime customers. Subprime lending involves higher capital requirements, greater regulatory scrutiny and more resources to underwrite and manage those accounts. Any concentrations in the subprime market are the result of banks’ conscious investment decisions, not barriers to entry.[35]

Capital One’s market entry coincided with the rise of direct marketing in the financial sector.[36] The company leveraged this trend by aggressively promoting its products through direct-mail offers, a strategy that helped it rapidly acquire customers and market share.[37] This direct-to-consumer approach bypassed traditional banking channels and allowed Capital One to build a national presence without the need for an extensive branch network.[38]

As the company grew, it continued to innovate in product design and customer acquisition. Capital One introduced features like balance transfers with low introductory rates, cashback rewards, and no annual fee cards, which were not common at the time.[39] The company was also one of the first banks to offer a secured credit card.[40] These offerings appealed to consumers and forced competitors to adapt, ultimately benefiting the broader market through increased competition and more favorable terms for cardholders.

Capital One’s disruptive influence extends beyond credit cards. The company has expanded into retail banking, auto financing, and savings products, often bringing its data-driven approach to these sectors.[41] For instance, its online savings accounts offer higher interest rates than many traditional banks, challenging the status quo and prompting other institutions to improve their offerings to remain competitive.[42]

III.   The Acquisition

Capitol One’s acquisition of Discover will have manifest benefits to consumers, competition, and innovation in the payment-card market. By combining the advantages of Discover’s existing (but somewhat stagnant) presence in the payment-card-network space and its reach into middle-class consumers with Capital One’s innovative culture in payments and data security and its marketing savvy, the deal offers the potential to create a viable competitor to existing mega-banks and the dominant card-processing networks. As noted, the proposed deal has elicited some criticism from politicians, but none of those criticisms have amounted to much more than a reflexive “big is bad” mentality and vague, unspecified concerns about the potential for harm to competition and consumers. By contrast, the potential benefits of the deal are manifest and concrete.

These benefits are explained in greater detail below, but in broad terms comprise the following two components:

1. The acquisition would likely lead to increased investment in innovation both at Capital One and among various competing banks, credit card issuers, and payment networks. Such investments would, among other things, result in reduced fraud, with both direct and indirect benefits to consumers and merchants. It would also likely lead to new products designed for more fine-grained customer groups.[43]
2. Capital One’s plan to switch its debit cards to Discover’s payment networks would lead to improved bank-account offerings, likely to include additional sign-on bonuses and/or cashback debit cards. These products would improve access to and encourage the adoption of fee-free checking accounts, especially for low-income consumers and those with lower credit scores.

This section analyses the various components of the proposed acquisition. From an industrial-organization perspective, this has both “horizontal” and “vertical” components. Both companies accept deposits, issue loans, offer credit and debit cards, and offer other financial services; the combination of these business lines would therefore be considered a horizontal merger. While such mergers have the potential to be anticompetitive, they can also be pro-competitive, as demonstrated by many horizontal “four-to-three” mergers in the wireless industry discussed in the first sub-section below.

While these horizontal aspects are tasty hors d’oeuvres, the main course in Capital One’s acquisition of Discover is its purchase of Discover’s payment networks, which would facilitate vertical integration with many of Capital One’s existing products (including all of its debit cards).[44] The main beneficial effects of this vertical aspect of the merger are addressed in the separate subsections on credit cards, debit cards, and banking. This is followed by a more detailed discussion of the effects of the merger on the identification and deterrence of fraud—and the benefits this would bring to consumers and merchants. The final subsection addresses some concerns raised by critics of the merger.

1.       Lessons from Horizontal “Four-to-Three” Mergers for Capital One-Discover Merger

Some lessons may be learned from mergers in other industries where two mid-size firms merge to create a competitor that is similar in size to the market leaders. An example is so-called “four-to-three” mergers in wireless telecommunications. A survey of empirical research on these mergers, undertaken by a team that included two of the authors of this white paper, provides insights that may help to evaluate the merger between Capital One and Discover.[45]

First, the paper notes the importance of considering both price and nonprice effects when assessing mergers. In the case of Capital One and Discover, while price effects (such as interest rates or fees) are crucial, nonprice factors like investments in technology, product innovation, and service-quality improvements should be given substantial weight.[46] The merger will enable the combined entity to increase investments in digital-banking capabilities, artificial intelligence, and data analytics—all areas where both companies have shown strengths. This increased investment capacity could lead to more innovative financial products and improved customer experiences, ultimately benefiting consumers.

Second, the review of empirical research highlights that mergers can lead to more symmetrical market structures (that is, with firms of more equal size), which may result in stronger incentives for individual firms to invest and compete.[47] In the context of the credit card and banking industries, a merged Capital One-Discover entity could become a more formidable competitor to larger players like JPMorgan Chase, Bank of America, and Citigroup. This increased symmetry in market power could drive all players to innovate and compete more aggressively, potentially leading to better offerings for consumers across the industry.

Lastly, the empirical research suggests that the optimal number of competitors in a market depends on various factors, including geographic and demographic considerations.[48] In the U.S. financial-services market, which is both large and geographically diverse, the merger could potentially create a stronger nationwide competitor. By combining Capital One’s extensive customer base and marketing prowess with Discover’s payment network and reputation for customer service, the merged entity could more effectively compete across different regions and customer segments. This could be particularly beneficial in making Discover a more effective competitor, as it would gain access to Capital One’s larger customer base and potentially expand the reach and utilization of its payment network.

B.      Credit Cards

Three networks currently account for approximately 96% of credit card purchase volume in the United States: Visa (52%), Mastercard (25%), and American Express (20%).[49] Discover has most of the remaining 4%, a proportion that has declined from 6% in 2011.[50] Capital One’s acquisition of Discover could potentially create a more robust fourth network, aligning with some legislators’ stated desire for an increase in the number of competitors in this market.[51]Unlike current proposed legislative interventions, however, it also would more plausibly lead to a genuine increase in competition, as Capital One would have strong incentives to identify ways to reinvigorate the network. Unlike some legislative proposals ostensibly intended to promote competition, but which likely would lead to increased fraud, the merger would likely improve the detection and prevention of fraud.

Capital One’s extensive cardholder base and innovative approach to payments could provide the scale and technological edge that Discover’s network has been lacking. Capital One’s data analytics capabilities and marketing prowess could be leveraged to expand the network’s reach, potentially making it more attractive to both merchants and consumers. This, in turn, could lead to a more competitive market in which four major players compete, potentially driving down transaction fees and spurring further innovation in payment technologies.

Moreover, whereas mandatory routing regulations—such as those contained in the Durbin amendment and the proposed Credit Card Competition Act—lead to data fragmentation that would undermine fraud detection, the combination of Capital One’s innovative data analytics with Discover’s networks would likely improve fraud detection. For example, Capital One recently partnered with Stripe and Ayden to build an open-source application programming interface (API) that enables any entity in the payment stack to share real-time transaction data, enabling Capital One to better detect fraud.[52]

C.     Debit Cards

The transaction also potentially offers an opportunity for Capital One to shift the debit cards of its current and future bank customers over to Discover’s payment networks. Capital One founder and CEO Richard Fairbank has stated that the company intends to transfer all its debit cards to the newly acquired networks.[53]

By moving customers onto Discover’s three-party payment card network, Capital One’s customers will be able to avoid the distortions imposed by the Durbin Amendment’s price controls. In turn, this will enable Capital One to offer rewards and maintain free checking accounts for lower-income consumers. These price controls only apply to debit cards issued on four-party payment networks, so Capital One will be able to avoid them by issuing debit cards on its own newly acquired three-party network.

Under a provision of the Dodd-Frank Wall Street Reform Act of 2010 known commonly as the “Durbin amendment,” the U.S. Federal Reserve imposed caps on debit card interchange fees for banks with more than $10 billion in assets (“covered banks”), as well as routing requirements for all debit card issuers.[54] As a result, debit card interchange fees fell by about 50% for large banks almost immediately. Interchange fees on debit cards issued by smaller banks and credit unions initially fell by a smaller amount, and interchange fees on single-message (PIN) debit cards have now fallen to similar levels as PIN debit cards issued by larger banks.[55]

Estimates suggest that the Durbin amendment initially reduced annual interchange fee revenue for covered banks by between $4.1 and $8 billion.54F^[56] In response, covered banks eliminated or reduced card-rewards programs on debit cards.62F^[57] They also typically raised monthly account maintenance fees and increased the minimum balance needed for a fee-free account.[58] These changes have resulted in an increase in unbanked and underbanked households in the United States, particularly among lower-income consumers.[59]

As a covered bank, Capital One might have been expected to have been among those that reduced the availability of free checking. But Capital One’s business model is focused on attracting the very clients who would be put off by having to pay a fee for their checking account. So, as noted above, it has kept fee-free checking accounts with zero minimum balances.[60] It has been able to do this, in part, because of its lower costs as a primarily online bank. As with most covered banks, however, Capital One discontinued its debit card rewards program following the implementation of the Durbin amendment.[61]

Capital One’s debit cards currently operate on four-party networks. By contrast, the Discover card network operates as a three-party closed-loop system, in which the issuer and the acquirer are the same and there is, therefore, no interchange fee. As such, debit cards issued directly by Discover are not subject to the Durbin amendment, which is why it is able to continue to offer cashback rewards of 1% on purchases made on those cards.[62] Shifting all of Capital One’s debit cards over to the Discover network (including, in particular, the PULSE single-message PIN-debit network) would allow Capital One to more effectively balance the two sides of the market, using fees charged to merchants to cross-subsidize holders of Capital One current accounts. This might include:

• Expanding access to fee-free checking accounts to low-income consumers and those with lower credit scores;
• Further encouraging adoption of checking accounts by offering higher rates of interest on deposits and/or rewards on debit card purchases; and/or
• Creating co-branded debit cards with specific merchants and offering additional rewards redeemable at those merchants.

D.     Data-Security Effects for Consumers and Merchants

Another potentially significant benefit of the merger is its effect on fraud, which is a challenge for every party in the payments ecosystem: issuers, acquirers, merchants, and cardholders. Global losses from payment-card fraud were estimated to be $34 billion in 2022, of which 36% was attributed to the United States.[63] By combining Capital One’s innovative approach to data management with Discover’s payment networks, the combined entity could help to significantly reduce such fraud.

Issuers and networks have developed increasingly sophisticated systems to reduce fraud. For example, when a card with a chip is dipped or tapped, it transfers a unique one-time token, generated by the chip, that is encrypted and can only be read by the issuer.[65] The implementation of chip-based tokenized transactions has dramatically reduced fraud compared to the simpler magnetic stripe cards. Mobile payments also use tokens in a similar way.

But tokens by themselves can’t solve the problem of stolen cards and hacked online accounts. Issuers and networks have thus implemented other measures, most notably systems of multifactor authentication. An example is 3D-Secure (3DS), which involves using the information sent in the first (authorization) message to check against a cardholder’s profile. If the proposed payment fits the profile, it is permitted; if not, then the cardholder is asked to complete two-factor authentication on the transaction.[66]

3DS would not be possible without cardholder profiles, which are an example of the application of AI to payments. Since the 1990s, Visa and Mastercard have used machine learning to develop cardholders profiles, which then enable them to identify potential instances of fraud.

Payment networks, issuers, and other companies in the card-processing stack have also begun to use biometrics, typically combined with machine learning, as part of the authentication and authorization process.[67] Capital One has been a leading innovator in such methods, going back at least to its pattern-tracing system for accessing mobile accounts.[68] From 2018 to 2020, Capital One applied for 23 biometric-related patents, including one for voice recognition.[69]

One problem that can reduce the effectiveness of AI-based fraud detection (including 3DS) is data fragmentation. When a consumer has cards from multiple issuers on multiple networks, or where the same card is run by different merchants over different networks (which is currently possible with debit cards, due to the Durbin amendment’s routing requirements), it may be difficult for networks and issuers to build a consistent picture of an individual’s payment patterns. This makes it more difficult to identify attempted payments that do not fit a pattern.

The merger might improve fraud detection in several ways. First, when Capital One’s debit cards are moved to Discover’s networks, they will no longer be subject to the Durbin amendment’s routing requirements, and thus all transactions on those cards will be monitored directly by Capital One’s systems. Second, Capital One will be able to implement its highly innovative fraud-detection and prevention systems across all Discover networks. Third, as noted above, Capital One recently partnered with Stripe and Ayden to build an open-source API that enables any entity in the payment stack to share real-time transaction data,[70] which should help Capital One to address fraud more effectively and in a manner comparable to existing larger networks (Visa, Mastercard, American Express) despite of its smaller size.

These improvements in fraud detection and prevention would have both direct and indirect benefits for merchants and consumers. The direct benefits arise from the simple fact of experiencing fewer fraudulent transactions. For consumers, this means not having to identify fraudulent transactions or go through the process of initiating chargebacks. For merchants, it means fewer chargebacks and related disputes with issuers. The indirect benefit is lower costs all around, which can be passed on in the form of lower fees and/or additional account or card benefits. And these increased benefits should be expected to drive an increase in the use of Capital One cards, thereby generating a virtuous cycle of network effects, whereby fraud can be reduced further, while use and acceptance of the cards are further increased.

E.      Banking (Deposits and Lending)

Critics of the merger have identified ways the proposed merger could harm banking consumers by increasing the cost of credit, increasing fees, and reducing the interest paid to depositors.[71] There is, however, little evidence the merger poses potential antitrust harm to depositors. Of note:

• Capital One is currently the ninth-largest bank in the United States by total assets, while Discover is the 27^th[72] The combined bank will have total assets of under $630 billion, making it the sixth-largest. This would still represent only 3.1% of domestic assets held by the largest commercial banks in the United States, and leave the combined entity less than one-quarter the size of the largest bank, JPMorgan Chase.[73]
• Similarly, the combined companies account for less than 3% of total bank deposits.[74]
• Because Discover has no branches, the merger would have little to no effect on the total number of bank branches in the United States. Indeed, it would arguably increase access to Capital One bank branches (and cafes) for Discover’s customers.

Capital One and Discover have both been industry leaders in increasing financial access for underserved consumers. For example, most bank accounts in the United States today impose monthly maintenance fees, especially for lower-income consumers who cannot meet the stiffer average balance requirements required to be eligible for free checking. Both Capital One’s 360 Checking Account and Discover’s Cashback Debit accounts offer free checking accounts with no minimum balance requirements. Capital One was also one of the first large banks to eliminate overdraft fees.

With such small market shares, it would be a stretch to conclude that a merger between Capital One and Discover would have any noticeable effect on competition for deposits or depositors in the U.S. banking sector. Moreover, as primarily online banks, Capital One and Discover compete nationally against other online banks, as well as “traditional” banks with substantial online presence. Thus, even if the merged firm were to try to charge above-competitive fees or offer below-competitive interest rates to depositors, such efforts would be likely to fail in the face of competition from hundreds of other competing banks and credit unions.

F.      Are There Any Competition Concerns?

Based on the above analysis, the prospective acquisition of Discover by Capital One augurs well for consumer welfare. As noted, however, some critics have raised concerns regarding certain aspects of the merger. Here, we briefly review these concerns.

1.       Credit cards

The merged firm would be the largest holder of credit card debt, accounting for nearly 22% of outstanding credit card loans by dollar amount.[75] That, in and of itself, is not necessarily a concern; as Capital One points out in its filing, it would not exceed any threshold in a conventional antitrust analysis.[76]

Much of the concern has been focused on potential harms to specific groups of credit card customers, especially the “near-prime” or “subprime” segments of borrowers with FICO scores below 660.[77] A key question for antitrust analysis is whether these constitute a distinct relevant market. One critic of the merger argues that these consumers’ higher risk, as well as Capital One and Discover’s direct-mail marketing to these consumers, suggest they constitute a distinct “submarket.”[78] In contrast, the Bank Policy Institute reports:

No evidence has been put forth by critics of the proposed merger to define the boundaries of the subprime segment and establish that consumers in this segment are sufficiently isolated for it to be considered a distinct submarket for antitrust purposes.[79]

One important consideration in evaluating this concern is that a consumer’s credit status is rarely static over time. Due to changes in income and other circumstances, a subprime borrower today may be a prime borrower next year, and vice versa. Using data from 2014 and 2015, Fair Isaac found that a “notable percentage” of FICO scores migrated up or down more than 20 points in a six-month period, with 14% of accounts decreasing by more than 20 points, and 19% increasing by more than 20 points.[80] Thus, even if a subprime or near-prime market segment can be defined, migration into and out of these segments makes it exceedingly difficult to establish a reliable market definition for antitrust analysis.

Among consumers with at least one credit card, as of 2023, 8.6% were near-prime and 4.4% subprime.[81] The Bank Policy Institute estimates the merged firm would account for a little less than 30% of subprime credit card balances in the United States.[82] Thus, the authors conclude, “If the subprime consumer segment of the credit card market merits separate scrutiny, our analysis indicates that the segment is highly competitive and would remain so even after the proposed merger.”[83]

It is also worth noting that Capital One gained its market share in “subprime” over time through its data-driven strategy. This has enabled the company to identify lower-risk individuals in (otherwise) higher-risk groups, thereby serving otherwise underserved consumers, while limiting default risk.[84] It also provides opportunities for these consumers to migrate toward a lower-risk category by gradually increasing the size of their credit lines as they demonstrate creditworthiness.[85]

Another important aspect of this strategy was the pioneering of two now-widespread credit card offerings: secured credit cards and balance transfers. In 1991, Capital One became the first credit card issuer to introduce a balance-transfer offer.[86] A balance transfer provides a temporarily low interest rate to induce people to move balances from a competing credit card to the card providing the balance-transfer offer. In short, Capital One’s substantial market share in the subprime credit card market is best explained by its innovative culture in meeting the needs of the heterogeneous consumers in this complex market.

Although perhaps not the first to offer a secured credit card, Capital One was arguably the first issuer to implement a major program of such cards.[87] A secured credit card differs from a traditional card in that all or part of the borrower’s credit limit is secured against a cash deposit provided by the consumer at the time of account opening. Secured cards are most useful to consumers seeking to build a credit history or attempting to repair a damaged credit history.[88] Research published by the Philadelphia Fed concludes that a combination of credit-score migration and increased competition has been associated with increasing “graduation rates” over time from secured cards to unsecured cards.[89]

Finally, for credit card issuers, a merger might result in a more effective competitor to the major incumbents, thereby potentially increasing competition, even while reducing the number of competitors. And a smaller number of larger firms facing more intense competition may be better for consumers than a larger number of smaller, less effective firms.

With respect to payment networks, it’s important to note that the proposed merger between Capital One and Discover does not reduce the number of competitors; it merely shifts ownership of Discover’s network to the merged firm, which would presumably adopt Capital One’s more sophisticated technologies, including those related to fraud detection, as discussed above. In this way, it could be argued that Capital One’s acquisition of Discover’s payments network might result in more effective competition to Visa, Mastercard, and American Express, with broad benefits to merchants and consumers.

2.       Debit cards

A major objective of the merger is, as noted above, to switch Capital One’s debit cards over to Discover’s payment network and thereby circumvent the Durbin amendment’s price controls and routing requirements. This vertical integration could allow for more flexibility in fee structures and potentially higher overall revenue per transaction. This would enable Capital One to offer cashback rewards to debit cards and potentially also cross-subsidize accounts in other ways, such as by offering sign-up bonuses.

Consumers would almost certainly benefit from the increased availability of debit card rewards and sign-up bonuses. Cashback rewards may be especially beneficial to lower-income cardholders. Indeed, it is likely that the reintroduction of such rewards will encourage some lower-income consumers, and especially those with poor credit scores and without access to a rewards credit card, to switch to Capital One. Moreover, the prospect of such rewards would likely entice many consumers who are currently unbanked or “underbanked” (i.e., have access to only minimal banking services) to open accounts with Capital One and thereby participate more fully in the banking system.

Of course, if Capital One does charge higher debit card transaction fees than four-party issuers, some merchants may choose to no longer accept its debit cards (and, if Capital One’s terms require merchants to accept all cards operating on its branded three-party network, also its credit cards). And if fewer merchants accept its cards, that will make the cards less attractive to consumers. Capital One will therefore have to balance such potential effects on merchants against the benefits to cardholders, just as Sears did in 1986 when it introduced Discover with lower than prevailing merchant fees in order to incentivize merchant acceptance.

From the perspective of merchants as a whole, the prospect of a larger proportion of consumers having bank accounts, and an even greater proportion paying by card rather than cash, should be attractive, given that card payments can result in increased sales (because consumers are able to spend more than they have in their wallet).[90] Meanwhile, having some consumers use debit cards rather than credit cards should also be attractive. As such, not only does it seem unlikely that many merchants would cease accepting Capital One cards, but it is also unlikely that Capital One switching its debit cards to Discover’s networks would cause net harm to social welfare.

From an antitrust perspective, it appears almost certain that, while some merchants may face higher costs of acceptance, this will be more than balanced by the increase in card-based transactions. Hence, there would be lower net costs for many merchants and an increase in consumer benefits arising from the rewards and other benefits the debit cards would now provide.

A similar issue lay at the heart of the U.S. Supreme Court’s decision in Ohio v. Amex:

Respondent… Amex… operate[s] what economists call a “two-sided platform,” providing services to two different groups (cardholders and merchants) who depend on the platform to intermediate between them. Because the interaction between the two groups is a transaction, credit-card networks are a special type of two-sided platform known as a “transaction” platform. The key feature of transaction platforms is that they cannot make a sale to one side of the platform without simultaneously making a sale to the other. Unlike traditional markets, two-sided platforms exhibit “indirect network effects,” which exist where the value of the platform to one group depends on how many members of another group participate. Two-sided platforms must take these effects into account before making a change in price on either side, or they risk creating a feedback loop of declining demand. Thus, striking the optimal balance of the prices charged on each side of the platform is essential for two-sided platforms to maximize the value of their services and to compete with their rivals.

Visa and MasterCard—two of the major players in the credit-card market—have significant structural advantages over Amex.  Amex competes with them by using a different business model, which focuses on cardholder spending rather than cardholder lending. To encourage cardholder spending, Amex provides better rewards than the other credit-card companies.  Amex must continually invest in its cardholder rewards program to maintain its cardholders’ loyalty.  But to fund those investments, it must charge merchants higher fees than its rivals.  Although this business model has stimulated competitive innovations in the credit-card market, it sometimes causes friction with merchants.[91]

Thus, the fact that some merchants may see their costs rise (slightly) as a result of the merger must be weighed against the significant benefits that accrue to consumers and other merchants.

IV.   Conclusion

Returning to the criteria by which the Federal Reserve and OCC are required to evaluate this merger, and in service of which this paper has been produced, (1) the convenience and needs of the communities to be served by the combined organization and (2) competition in the relevant markets, the forgoing analysis leads to the following conclusions:

• By switching its debit cards to Discover’s payment networks, Capital One might offer more attractive products to depositors. In particular, it could expand access to free checking accounts with no minimum balance requirements to a wider range of low-income consumers. And it could offer debit cards with cashback to lower-income consumers who would not qualify for credit cards. The benefits for this important underserved community could be enormous.
• In combination, Capital One and Discover would be the sixth-largest U.S. bank by assets. Cost savings and other synergies could make it a more effective competitor in the large national bank market, driving improvements in its own offerings, as well as among other, similarly sized banks that serve large segments of the U.S. population.
• The combined Capital One-Discover would become the third-largest credit card issuer by purchaser volume, after JPMorgan Chase and American Express. As with its banking operations, its scale and innovative approach could drive improvements both directly for its customers and indirectly for the customers of other banks. In particular, it would likely lead to significant reductions in fraud, which could result in a virtuous cycle of increased use and acceptance.
• Discover’s credit card network is currently the fourth largest in the United States, accounting for only about 4% of payment volumes and thus trailing far behind Visa, MasterCard, and American Express. Through these investments, especially in fraud detection and prevention, and the resulting network effects, Capital One may be able to leverage Discover’s card network to allow it to compete more successfully.

Through these effects, Capital One may attract additional customers, especially those with low incomes or lower credit scores, thereby more effectively meeting the convenience and needs of the communities it serves. At the same time, and for largely the same reasons, it would arguably increase competition in most relevant markets and is unlikely substantially to diminish competition in any markets.

[1] Press Release, Capital One to Acquire Discover, Capital One (Feb. 19, 2024), https://investor.capitalone.com/news-releases/news-release-details/capital-one-acquire-discover.

[2] Press Release, Board of Governors of the Federal Reserve System & Office of the Comptroller of the Currency, Agencies Announce Public Meeting on Proposed Acquisition by Capital One of Discover; Public Comment Period Extended, Federal Reserve Board (May 14, 2024), https://www.federalreserve.gov/newsevents/pressreleases/other20240514a.htm; Press Release, Agencies Announce Public Meeting on Proposed Acquisition by Capital One of Discover; Public Comment Period Extended, Office of the Comptroller of the Currency (May 14, 2024), https://www.occ.gov/news-issuances/news-releases/2024/nr-ia-2024-50.html.

[3] See, Letter to the Honorable Michael Barr, Vice Chair of Supervision for the Board of Governors of the Federal Reserve System and Acting Comptroller Michael Hsu, Office of the Comptroller of the Currency from the Undersigned Members of the Congress of the United States, Office of Sen. Elizabeth Warren (Feb. 25, 2024), available at https://www.warren.senate.gov/imo/media/doc/2024.02.25%20Capital%20One%20Letter1.pdf.

[4] See, Letter to the Honorable Jerome Powell, et. al from the Undersigned Members of the U.S. House of Representatives Committee on Financial Services, House Financial Services Committee Democrats (Feb. 28, 2024), available at https://democrats-financialservices.house.gov/uploadedfiles/02.28_-_ltr_on_ibmr.pdf.

[5] See, Letter to Jonathan Kanter, Assistant Attorney General of the U.S. Department of Justice, Antitrust Division from Senator Josh Hawley, Office of Sen. Josh Hawley (Feb. 21, 2024), available at https://www.hawley.senate.gov/wp-content/uploads/files/2024-02/Hawley-Letter-to-Kanter-re-Capital-One-Discover-Merger.pdf.

[6] See, e.g., Julian Morris & Todd Zywicki, Regulating Routing in Payment Networks (ICLE White Paper 2022-08-17), available at https://laweconcenter.org/wp-content/uploads/2022/08/Regulating-Routing-in-Payment-Networks-final.pdf; Julian Morris, The Credit Card Competition Act’s Potential Effects on Airline Co-Branded Cards, Airlines, and Consumers (ICLE White Paper 2023-11-17), available at https://laweconcenter.org/wp-content/uploads/2023/11/CCCA-Airline-Rewards-Study-v4.pdf.

[7] The list of relevant criteria for consideration includes: the convenience and needs of the communities to be served by the combined organization; each insured depository institution’s performance under the Community Reinvestment Act; competition in the relevant markets; the effects of the proposal on the stability of the U.S. banking or financial system; the financial and managerial resources and future prospects of the companies and banks involved in the proposal; and the effectiveness of the companies and banks in combatting money laundering activities. See Joint Press Release, supra note 4; 12 U.S.C. § 1828(c).

[8] See, Federal Reserve Board, Insured U.S.-Chartered Commercial Banks That Have Consolidated Assets of $300 Million or More, Ranked by Consolidated Assets as of March 31, 2024, Federal Reserve Board (Mar. 31, 2024), https://www.federalreserve.gov/releases/lbr/current.

[9] See, Federal Reserve Bank of New York, Quarterly Report on Household Debt and Credit, 2023:Q4, Federal Reserve Board (Feb. 2024),  https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2023Q4; 20 Bank Holding Companies With the Largest Credit Card Loan Portfolios, American Banker (Mar. 28, 2024), https://www.americanbanker.com/list/20-bank-holding-companies-with-the-largest-credit-card-loan-portfolios-at-the-end-of-q4.

[10] See Shahid Naeem, Capital One-Discover: A Competition Policy and Regulatory Deep Dive, American Economic Liberties Project (Mar. 2024), available at https://www.economicliberties.us/wp-content/uploads/2024/03/2024-03-20-Capital-One-Discover-Brief-post-design-FINAL.pdf.

[11] See Diana Moss, The Capital One Financial-Discover Financial Services Merger: A Test for the Biden Merger Agenda?, Progressive Policy Institute (Jun. 20, 2024), at 1, available at https://www.progressivepolicy.org/wp-content/uploads/2024/06/PPI-Capitol-One-Discover-Commentary.pdf.

[12] Application to the Board of Governors of the Federal Reserve System for Prior Approval for Capital One Financial Corporation to Acquire Discover Financial Services  Pursuant to Section 3 of the Bank Holding Company Act and Section 225.15 of Regulation Y, Federal Reserve Board(Mar. 20, 2024), at 40, available at https://www.federalreserve.gov/foia/files/capital-one-application-20240320.pdf [hereinafter “Capital One Application”].

[13] See, New Sears Credit Card by Year-End, Chicago Tribune (Apr. 25, 1985), https://www.chicagotribune.com/1985/04/25/new-sears-credit-card-by-year-end.

[14] See Nancy Yoshihara, Sears Unveils Its New Credit Card: Multipurpose “Discover” to Get 1^st Test Marketing in Fall, Los Angeles Times (Apr. 25, 1985), https://www.latimes.com/archives/la-xpm-1985-04-25-fi-12317-story.html.

[15] Id.

[16] See Todd J. Zywicki, The Economics of Payment Card Interchange Fees and the Limits of Regulation (ICLE Financial Regulatory Program White Paper Series, Jun. 2, 2010), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1624002.

[17] See Chicago Tribune, supra note 13.

[18] See Jack Caporal, Average Credit Card Processing Fees and Costs in 2024, the ascent, https://www.fool.com/the-ascent/research/average-credit-card-processing-fees-costs-america, (last updated Jun. 5, 2024), (noting that “Discover credit card processing fees have the lowest range, excluding outliers.”).

[19] See Eric Schmuckler, Playing Your Cards Right, Forbes (Dec. 28, 1987).

[20] See, Discover—Dawn of Discover, AdAge (Jan. 26, 1986), https://adage.com/videos/discover-dawn-of-discover/1241.

[21] See Frances Denmark, Discover CEO David Nelms Reinvents His Credit Card Firm, Institutional Investor (Dec. 28, 2011), https://www.institutionalinvestor.com/article/2bszspjc02cwjwn5f2pds/portfolio/discover-ceo-david-nelms-reinvents-his-credit-card-firm.

[22] Michael Weinstein, Bankers: DiscoverCard Has Not Hurt Business, American Banker (Mar. 7, 1988).

[23] Diners Club and MasterCard Finalize Alliance, The Payers (Sep. 27, 2004), https://thepaypers.com/payments-general/diners-club-and-mastercard-finalize-alliance–724076.

[24] See, e.g., The Story Behind The Card, Diners Club Int’l, https://www.dinersclubus.com/home/about/dinersclub/story (last accessed Jul. 17, 2024); Press Release, BMO Financial Group Announces Agreement to Acquire the Diners Club North American Franchise From Citigroup, BMO Financial Group (Nov. 24, 2009), https://newsroom.bmo.com/2009-11-24-BMO-Financial-Group-Announces-Agreement-to-Acquire-the-Diners-Club-North-American-Franchise-From-Citigroup.

[25] See Denmark, supra note 21.

[26] See Adam McCann, Market Share by Credit Card Network, WalletHub (May 9, 2024), https://wallethub.com/edu/cc/market-share-by-credit-card-network/25531.

[27] See Fred Ashton, Capital One’s Acquisition of Discover Could Inject Competition Into Payments Market, American Action Forum Insight (Feb. 29, 2024), at fig. 2, https://www.americanactionforum.org/insight/capital-ones-acquisition-of-discover-could-inject-competition-into-payments-market.

[28] Michelle Price, Exclusive: CapOne Tells Regulators Discover Deal will Boost Competition and Stability, Reuters (Mar. 21, 2024), https://www.reuters.com/markets/deals/capone-tells-regulators-discover-deal-will-boost-competition-stability-sources-2024-03-21.

[29] Capital One Financial Corporation, Capturing the Essence of Capital One: 1996 Annual Report 2-3 (1996), available athttps://investor.capitalone.com/static-files/d823fcd3-e1f1-439a-a34f-5296ef58b93c.

[30] See id. at 3, 5-6.

[31] Id. at 3.

[32] See David Morrison & Adrian Slywotzky, Off the Grid, Industry Standard (Oct. 23, 2000).

[33] See Andrew Becker, The Secret History of the Credit Card, Frontline (Nov. 23, 2004), https://www.pbs.org/wgbh/pages/frontline/shows/credit/more/battle.html.

[34] See Morrison & Slywotzky, supra note 32.

[35] Sheila Bair, How the Capital One/Discover Deal Could Boost Competition, Financial Times (May 31, 2024), https://on.ft.com/4640E6h.

[36] See Morrison & Slywotzky, supra note 32.

[37] See Zack Martin, Capital One Makes Big Push to Become a National Brand, Card Marketing (Dec. 2000).

[38] See Jon Prior, Capital One Keeps Closing Branches, Even as Rivals Open Them, American Banker (Jul. 1, 2019), https://www.americanbanker.com/news/capital-one-keeps-closing-branches-even-as-rivals-open-them.

[39] See Lukasz Drozd, Why Credit Cards Played a Surprisingly Big Role in the Great Recession, 6(2) Econ. Insights 10 (Mar. 2021), n. 12, https://fraser.stlouisfed.org/title/6149/item/604454?start_page=ii.

[40] Naomi Snyder, Capital One’s Secret to Success, Bank Director (Aug. 15, 2022), https://www.bankdirector.com/article/capital-ones-secret-to-success (Capital One “invented the secure credit card”); Larry Santucci, The Secured Credit Card Market, Federal Reserve Bank of Philadelphia(Nov. 2016), available at https://www.philadelphiafed.org/-/media/frbp/assets/consumer-finance/discussion-papers/dp16-03.pdf (“While we were unable to identify the first bank to issue a secured card, the innovation is believed to have occurred sometime in the late 1970s.”).

[41] See Alex Woodie, The Modernization of Data Engineering at Capital One, Datanami (Apr. 4, 2022), https://www.datanami.com/2022/04/04/the-modernization-of-data-engineering-at-capital-one.

[42] See, e.g., Sabrina Karl, Best High-Yield Savings Accounts of July 2024—Up to 5.55%, Investopedia,  https://www.investopedia.com/best-high-yield-savings-accounts-4770633 (last updated Jul. 17, 2024), (listing Capital One and Discover among the highest-available interest rates for new accounts).

[43] See Anish Kapoor, Capital One-Discover Acquisition: Unpicking [sic] the Consumer and Competitive Benefits, LinkedIn.com (Apr. 15, 2024), available at https://www.linkedin.com/pulse/capital-one-discover-acquisition-unpicking-consumer-benefits-kapoor-53yge.

[44] Capital One itself lists “Combin[ing] Capital One’s scale in credit cards and banking with Discover’s vertically integrated global payments network” and “Enhanc[ing] Capital One’s ability to compete with the national’s largest banks in credit cards and banking” as the top two reasons for its “strategic rationale.” Investor Presentation, Capitol One & Discover (Feb. 20, 2024), at 4 https://investor.capitalone.com/static-files/cfa11729-0aec-43dc-b531-200e250c8413.

[45] See Eric Fruits, Justin (Gus) Hurwitz, Geoffrey A. Manne, Julian Morris, & Alec Stapp, Static and Dynamic Effects of Mergers: A Review of the Empirical Evidence in the Wireless Telecommunications Industry (OECD, DAF/COMP/GF(2019)13, Dec. 6, 2019), available at https://one.oecd.org/document/DAF/COMP/GF(2019)13/en/pdf.

[46] Id. at 17.

[47] Id. at 8.

[48] Id. at 3.

[49] Caitlin Mullin, Capital One Pledges to Give Discover’s Network a Boost, Payments Dive (Mar. 26, 2024), https://www.paymentsdive.com/news/capital-one-discover-acquisition-federal-reserve-occ-debit-credit-card-network-visa-mastercard/711385.

[50] Id.; see also, Leading Credit Card Issuers in the United States from 2007 to 2023, Based on Value of Transactions for Goods and Services,Statista (Feb. 2024), https://www.statista.com/statistics/1080768/leading-credit-card-issuers-usa-by-purchase-volume.

[51] See, e.g., Press Release, Sen. Dick Durbin, Durbin, Marshall Announce Hawley, Reed as New Cosponsors, Growing Support for Credit Card Competition Act, Office of Sen. Dick Durbin (Feb. 14 2024), https://www.durbin.senate.gov/newsroom/press-releases/durbin-marshall-announce-hawley-reed-as-new-cosponsors-growing-support-for-credit-card-comptition-act (arguing that “[f]or too long, the Visa-Mastercard duopoly alongside the Wall Street megabanks have price-gouged hardworking Americans with little-to-no oversight” and “[f]or years, Visa and Mastercard have taken advantage of their duopoly in the credit market to impose extreme fees on small merchants and retailers.”).

[52] Mary Ann Azevedo, When Foes Become Friends: Capital One Partners with Fintech Giants Stripe, Adyen to Prevent Fraud, TechCrunch (Jun. 5, 2024), https://techcrunch.com/2024/06/05/when-foes-become-friends-capital-one-partners-with-fintech-giants-stripe-adyen-to-prevent-fraud.

[53] Transcript of Conference Call Held by Capital One Financial Corporation and Discover Financial Services on February 20, 2024, Filed by Capital One Financial Corporation (Commission File No.: 001-13300), available at https://investor.capitalone.com/static-files/d7b64c07-9663-4b0a-b382-48792a04c148:

“So, on the debit side with the Discover Global Network, with the Pulse PIN debit network, along with their Discover signature debit network, it’s really well-positioned and in a strong position to just basically take our debit volume at this place and at this point, and we feel comfortable moving our entire business over there.” See also, supra note 49 (“Currently, Capital One’s debit cards run on Mastercard’s network, and all of that volume will move to Discover’s network, Capital One executives said Tuesday. Some portion of Capital One’s credit cards will move to Discover’s payment rails as well, Fairbank said. Capital One issues cards on both the Visa and Mastercard networks, with about 42% of the bank’s credit cards running on Visa and 58% on Mastercard, as of 2022, according to Bank of America Securities analysts.”.

[54] H.R.4173 – Dodd-Frank Wall Street Reform and Consumer Protection Act, s.1075(a)(3); Debit Card Interchange Fees and Routing; Final Rule, 76 Fed. Reg. 43,393-43,475, (Jul. 20, 2011).

[55] Todd J. Zywicki, Geoffrey A. Manne, & Julian Morris, Unreasonable and Disproportionate: How the Durbin Amendment Harms Poorer Americans and Small Businesses, Int’l Cntr For L. & Econ. (Apr. 25, 2017), available at https://laweconcenter.org/wp-content/uploads/2017/08/icle-durbin_update_2017_final-1.pdf.

[56] See, e.g., Benjamin S. Kay, Mark D. Manuszak, & Cindy M. Vojtech, Competition and Complementarities in Retail Banking: Evidence From Debit Card Interchange Regulation, 34 J. Fin. Intermediation 91, 92 (2018) (estimating losses of interchange income between $4.1-$6.5 billion); Vladimir Mukharlyamov & Natasha Sarin, Price Regulation in Two-Sided Markets: Empirical Evidence From Debit Cards (Dec. 2019), https://ssrn.com/abstract=3328579 (estimating $5.5 billion annual revenue loss to banks from interchange-fee reductions); Bradley G. Hubbard, The Durbin Amendment, Two-Sided Markets, and Wealth Transfers: An Examination of Unintended Consequences Three Years Later, SSRN (May 20, 2013), at 20, https://ssrn.com/abstract=2285105 (estimating annual revenue loss of $6.6 billion to $8 billion from the Durbin amendment).

[57] See Darryl E. Getter, Regulation of Debit Interchange Fees, Congressional Research Service (May 16, 2017), at 8. See also Electronic Payments Coalition, Out of Balance: How the Durbin Amendment Has Failed to Meet Its Promises 7 (Dec. 2018), available at https://www.electronicpaymentscoalition.org/wp-content/uploads/2018/12/EPC.DurbinStudiesPaper.pdf (Eliminating rewards, such as cash-back on purchases, is functionally equivalent to a price increase).

[58] Mark D. Manuszak & Krzysztof Wozniak, The Impact of Price Controls in Two-Sided Markets: Evidence From US Debit Card Interchange Fee Regulation (Bd. of Governors of the Fed. Res. Sys. Fin. & Econ. Discussion Series, Working Paper No. 2017-074, 2017); Mukharlyamov & Sarin, supra note 56.

[59] Mukharlyamov & Sarin, supra note 56.

[60] See Aly J. Yale, Everything You Need to Know About Banking with Capital One, Wall Street Journal (May 28, 2024), https://www.wsj.com/buyside/personal-finance/banking/capital-one-bank-review.

[61] See Blake Ellis, Wells Fargo, Chase, SunTrust cancel debit rewards program, CNN Money (Mar. 28, 2011), https://money.cnn.com/2011/03/25/pf/debit_rewards/index.htm (noting the move by major banks to cancel debit-card rewards in anticipation of the Durbin amendment going into effect); Richard Kerr, Where Have All the Rewards Debit Cards Gone?, The Points Guy (Jun. 24, 2015), https://thepointsguy.com/credit-cards/rewards-debit-cards-gone (describing the “slow death of debit cards that earn points and miles.”).

[62] See, e.g., Earn Cash Back Rewards with No Fees, Discover (2024), https://www.discover.com/online-banking/checking-account.

[63] Kalle Radage, Credit Card Fraud in 2023, Clearly Payments (Aug. 13, 2023), https://www.clearlypayments.com/blog/credit-card-fraud-in-2023.

[65] EMV chips use a form of public-key infrastructure. The token is encrypted using the issuer’s public key and can only be decrypted using the issuer’s private key. After decrypting the token (technically, a cryptogram), the issuer can validate the transaction by checking its authenticity and integrity. If the token is validated successfully, the issuer authorizes the transaction. If the token cannot be validated, the transaction is declined.

[66] See Elint Chu, What Is New with EMV 3DS v.2.3?, EMVCo (Nov. 12, 2021), https://www.emvco.com/knowledge-hub/what-is-new-with-emv-3ds-v2-3.

[67] See, e.g., NuData: It’s Time for Businesses to Replace the Old ‘New Normal’ With a New One, PYMNTS (Jun. 30, 2021), https://www.pymnts.com/news/payments-innovation/2021/nudata-time-businesses-replace-old-new-normal; Chris Burt, Smartmetric CEO Claims Progress Towards American Biometric Payment Card Launch, Biometric Update (Jul. 18, 2022), https://www.biometricupdate.com/202207/smartmetric-ceo-claims-progress-towards-american-biometric-payment-card-launch.

[68] See Jim Bruene, Capital One Launches SureSwipe for Gesutre-Based Mobile Login, Finovate (Nov. 11, 2013), https://finovate.com/capital_ones_gesture-based_mobile_login_sureswipe.

[69] Capital One Patent Looks To Bring Voice Recognition Technology To Mobile Payments, CBInsights (Oct. 13, 2020), https://www.cbinsights.com/research/capital-one-patent-voice-recognition-tech-mobile-payments.

[70] See supra note 52 and accompanying text.

[71] See supra notes 3-5 and accompanying text.

[72] See Federal Reserve Board, supra note 8.

[73] Id.

[74] See Capital One Application, supra note 12, at 39.

[75] See Federal Reserve Board, supra note 8.

[76] See Capital One Application, supra note 12, at 39-40.

[77] CFPB provides the following definitions: superprime (800 or greater), prime plus (720 to 799), prime (660 to 719), near-prime (620 to 659), subprime (580 to 619), and deep subprime (579 or less). Consumer Financial Protection Bureau, The Consumer Credit Card Market 12 (Oct. 2023), available at https://files.consumerfinance.gov/f/documents/cfpb_consumer-credit-card-market-report_2023.pdf.

[78] Naeem, supra note 10, at 17.

[79] Haelim Anderson, Paul Calem, & Benjamin Gross, Is the Subprime Segment of the Credit Card Market Concentrated? Bank Policy Institute(May 31, 2024), https://bpi.com/is-the-subprime-segment-of-the-credit-card-market-concentrated.

[80] See Fair Isaac Corporation, FICO Research: Consumer Credit Score Migration (2018), https://www.fico.com/en/latest-thinking/white-paper/fico-research-consumer-credit-score-migration.

[81] CFPB, supra note 77, at 16—17.

[82] See Anderson, Calem, & Gross, supra note 79, at Panel C.

[83] Id. at Conclusion.

[84] Becker, supra note 33 (“By identifying lower-risk individuals in high-risk groups, Capital One was able to market to reliable consumers other companies wouldn’t touch, says [Chris] Meyer [CEO of Monitor Networks]. In just six years, Capital One became the sixth-largest credit card issuer in the country. “When others were attacking the market with blunt instruments, Capital One used a scalpel,” says Meyer.”).

[85] Snyder, supra note 40 (“Sanjay Sakhrani, an equity analyst and managing director at the investment bank Keefe, Bruyette & Woods, says the bank focuses its efforts on the most profitable risk-adjusted return segments. “I think they’ve done a very effective job [of] underwriting and managing risks inside of the subprime population,” he says. The bank starts by offering those customers low credit lines and graduates them over time as they demonstrate their credit worthiness.”).

[86] See Drozd, supra note 39.

[87] See Snyder, supra note 40.

[88] See, e.g., Ian McGroarty, CFI in Focus: Secured Credit Cards, Federal Reserve Bank of Philadelphia (Sep. 2019), at 1-2, available athttps://www.philadelphiafed.org/-/media/frbp/assets/consumer-finance/articles/secured-credit-cards.pdf.

[89] Id. at 6-7.

[90] Sumit Agarwal, Wenlan Qian, Yuan Ren, Hsin-Tien Tsai, and Bernard Yeung, Mobile Wallet and Entrepreneurial Growth, AEA Papers and Proceedings, 109:48–53 (2019);  David Bounie and Youssouf Camara, Card-Sales Response to Merchant Contactless Payment Acceptance, Journal of Banking & Finance, Vol. 119, issue C. (2020).

[91] Ohio v. American Express Co., 138, S.Ct. 2274, 2276-77, 585 U.S. 529 (2018).

As former antitrust enforcers and alumni of the Federal Trade Commission (“FTC”), we are pleased to submit these comments to the FTC and Department of Justice’s Antitrust Division (“DOJ”) (collectively, “Agencies”) in response to your Request for Information on Corporate Consolidation Through Serial Acquisitions and Roll-Up Strategies (“RFI”).  We have devoted significant portions of our careers to protecting consumers and competition and we continue to care deeply about the Agencies and their mission.  Moreover, we agree that mergers and acquisitions merit further study and applaud the Agencies for tackling these issues.

We write to suggest several ways in which the Agencies might adjust and supplement the RFI to build confidence in its objectivity and comprehensiveness.  As written, the RFI creates an appearance that the Agencies are mainly seeking negative information about acquisitions, rather than seeking to learn about their benefits to competition as well as their potential harms, and that the Agencies are seeking information about ideological topics untethered from their mission.  Such an approach could distort the Agencies’ perspective, degrade public confidence, and ultimately lead the Agencies to challenge pro-competitive or competitively neutral acquisitions.

I. The Agencies Should Issue a Supplemental RFI to Inquire into the Pro-Competitive Aspects of Serial Acquisitions

As they have in the past, the Agencies should examine mergers and acquisitions in an objective fashion.  In recent years, for example, the Agencies themselves have recognized that mergers “are one means by which firms can improve their ability to compete.”[1]  In one paper, from 2020, the FTC’s staff examined a large potash merger and concluded that the “evidence does not indicate that the firms were able to impose an anticompetitive price increase in the wake of the merger.”[2]  Another retrospective from 2009, into hospital mergers, found mixed results; one merger resulted in higher prices, the other did not.[3]  Finally, a retrospective into grocery mergers found that “mergers in highly concentrated markets are most frequently associated with price increases, while mergers in less concentrated markets are most often associated with price decreases.”[4]  In each instance, the Agencies examined the markets and acquisitions objectively.

The current RFI, however, suggests that the Agencies have already concluded that “serial acquisitions” harm competition.  Although several questions take a neutral approach, many of them solicit negative information about acquisitions, and not one asks about any benefits. For example, Question 2(c) asks whether serial acquisitions encourage “actual or attempted coordination or collusion between competitors” and Question 3 posits nine subparts about ways in which an acquirer might harm competition, including tying and refusals to deal.  By contrast, the RFI includes no questions that solicit information about possible pro-competitive benefits from acquisitions; at most, Question 4 asks the public to identify “claimed” business objectives and whether they came to pass.

Accordingly, we suggest that the Agencies supplement the RFI with additional questions that solicit information about the benefits of serial acquisitions.  Below is proposed Question 6, mirroring existing Question 3:

Proposed Question 6

Serial Acquisition Business Practices (Part 2): If you identified serial acquisitions in the preceding questions, please share whether the acquisitions affected the relevant market in in any of the following ways:

1. A reduction in price for consumers, either by the acquirer, its competitors, or both;

2. An increase in output, either by the acquirer, its competitors, or both;

3. An increase in product offerings, including new varieties of products or products offered at different price points, either from the acquirer, its competitors, or both;

4. An increase in product quality, either from the acquirer, its competitors, or both;

5. An increase in investment, financing, or innovation, as measured by patent filings or any other metric, either by the acquirer, its competitors, or both;

6. An increase in efficiency (e.g., lower unit costs), either by the acquirer, its competitors, or both;

7. Any other market effects that show the benefits of the acquisitions; and

8. Any other market effects that show that the acquisitions were competitively neutral in terms of their effect on price, quality, variety, investment, or any other metric.

At a minimum, the addition of these questions, or something similar, would build public confidence that the Agencies are approaching the topic in an objective manner.

Moreover, the answers also could yield valuable, current information about the benefits of acquisitions — and thereby improve the Agencies’ ability to develop better enforcement actions.  In the past, of course, the Agencies have stated that “the vast majority of mergers are either procompetitive and enhance consumer welfare or are competitively benign”[5] and that “[m]ergers are one means by which firms can improve their ability to compete.”[6]  In a policy statement from just a few years ago, the FTC agreed that mergers can promote innovation:

[I]n dynamic sectors characterized by high R&D costs, firms with broad scale and scope may have unique incentives and capabilities to invest in innovation.  For example, where a firm can exploit synergies across product lines or earn returns on research and development projects across multiple geographies, it may have greater incentives to make investments in such projects than firms with more limited operations.[7]

Many other studies agree that mergers can promote competition and innovation.  The Antitrust Modernization Commission,[8] antitrust treatises,[9] and a recent, comprehensive literature survey[10] all have found that mergers can and do advance procompetitive business objectives.  Another recent study found that mergers resulted in more patent applications and investment in research and development. [11]  In the biopharmaceutical industry, for instance, the Congressional Budget Office agreed that “The acquisition of a small company by a larger one can create efficiencies that might increase the combined value of the firms by allowing drug companies of different sizes … to specialize in activities in which they have a comparative advantage.”[12]  Numerous recent court decisions also find that mergers can create integration efficiencies that ultimately promote competition and benefit consumers.[13]

II. The Agencies Should Explain or Withdraw Certain Questions that Create an Appearance of Focusing on Ideological Issues Unrelated to Their Statutory Mission

Within the RFI, certain questions may create an appearance that the Agencies are interested in ideological issues unrelated to their statutory mission.  For example, Question 2(d) and its subparts inquire into labor topics unrelated to the rare phenomenon of a labor monopsony, such as “Have workers been reclassified (i.e., from employees to independent contractors) or outsourced to/from third-party providers?” and questions about “work conditions” and “employment stability.”  It is not obvious how any of these questions relate to the Agencies’ statutory mission or historical practice. The RFI cites no statutory provisions or cases, and we are unaware of any, in which a court has found that issues of worker classification, work conditions, or employment stability had any relevance to a merger analysis.

Similarly, Question 5 asks a series of questions about private equity and the role that investors play in managing an acquired company.  Again, the RFI cites no statutory provisions or cases, and we are unaware of any, in which a court has found that the identity of a purchaser as a private equity firm has any relevance to a merger analysis, except to the extent that the firm may own other companies in the same market.

For these reasons, we recommend that the Agencies withdraw these questions or explain their relevance to the antitrust laws and this inquiry.  By narrowing the RFI to topics that relate directly to the antitrust laws and merger analysis, and that have grounding in the statutory language and historical precedent, the Agencies would gather more useful information and would increase public confidence in the necessity and utility of this inquiry.

***

As former enforcers, we strongly support the Agencies’ mission and the importance of vigorous enforcement.  We hope that our suggestions will help the Agencies to improve the quality and utility of the information that they receive in response to this RFI.

Thank you for your attention to these comments.

[1] OECD, Conglomerate Effects of Mergers – Note by the United States to the Organisation for Economic Co-operation and Development (June 4, 2020) at 5, https://www.ftc.gov/system/files/attachments/us-submissions-oecd-2010-present-other-international-competition-fora/oecd-conglomerate_mergers_us_submission.pdf.

[2] See Kreisle, Bureau of Economics, Price Effects from the Merger of Agricultural Fertilizer Manufacturers Agrium and PotashCorp (July 2020), https://www.ftc.gov/system/files/documents/reports/price-effects-merger-agricultural-fertilizer-manufacturers-agrium-potashcorp/working_paper_345.pdf.

[3] See Haas-Wilson and Garmon, Bureau of Economics, Two Hospital Mergers on Chicago’s North Shore: A Retrospective Study (Jan. 2009), at https://www.ftc.gov/sites/default/files/documents/reports/two-hospital-mergers-chicago%E2%80%99s-north-shore-retrospective-study/wp294_0.pdf.

[4] See Hosken et al, Bureau of Economics, Do Retail Mergers Affect Competition? Evidence from Grocery Retailing (Dec. 2012), https://www.ftc.gov/sites/default/files/documents/reports/do-retail-mergers-affect-competition%C2%A0-evidence-grocery-retailing/wp313.pdf.

[5] Statement of Ass’t Att’y Gen. Christine Varney, Merger Guidelines Workshops, Third Annual Georgetown Law Global Antitrust Enforcement Symposium (Sept. 22, 2009).

[6] OECD, Conglomerate Effects of Mergers – Note by the United States to the Organisation for Economic Co-operation and Development (June 4, 2020) at 5, https://www.ftc.gov/system/files/attachments/us-submissions-oecd-2010-present-other-international-competition-fora/oecd-conglomerate_mergers_us_submission.pdf.

[7] Id. at 8.

[8] E.g., Antitrust Modernization Commission Report 57-60, at https://govinfo.library.unt.edu/amc/report_recommendation/amc_final_report.pdf.

[9] 4A Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law ¶ 10A-1 (5th ed. 2021).

[10] U.S. Chamber, Evidence of Efficiencies in Consummated Mergers (June 1, 2023), at https://www.uschamber.com/assets/documents/20230601-Merger-Efficiencies-White-Paper.pdf.

[11] U.S. Chamber, Mergers, Industries, and Innovation: Evidence from R&D Expenditures and Patent Applications (Feb. 2023), at https://www.uschamber.com/finance/antitrust/mergers-industries-and-innovation-evidence-from-r-d-expenditure-and-patent-applications.

[12]CBO, Research and Development in the Pharmaceutical Industry (Apr. 2021), at https://www.cbo.gov/publication/57126 . .

[13] Microsoft, 2023 WL 4443412, at *11 (citations omitted).  See also U.S. v. Booz Allen Hamilton, Case 1:22-cv-01603-CCB, at 8 n.13 (D. Md. Oct. 17, 2022); Nat’l Fuel Gas Supply Corp. v. FERC, 468 F.3d 831, 840 (D.C. Cir. 2006) (“[V]ertical integration creates efficiencies for consumers”).

Like Jason Voorhees in each new iteration of the “Friday the 13th” franchise, net neutrality is coming back from the dead. With a Democratic majority now in place on the Federal Communications Commission, the commissioners recently voted 3-2 to reinstate net neutrality rules the FCC repealed in 2018. This decision to reclassify how broadband is regulated also sets the stage for even more expansive rules than the ones that existed before.

Read the full piece here.

STATEMENTS OF INTEREST

The International Center for Law & Economics (“ICLE”) is a nonprofit, non-partisan global research and policy center that builds intellectual foundations for sensible, economically grounded policy. ICLE promotes the use of law and economics methodologies and economic learning to inform policy debates and has longstanding expertise evaluating law and policy.

ICLE scholars have written extensively in the areas of telecommunications and broadband policy. This includes white papers, law journal articles, and amicus briefs touching on issues related to the provision and regulation of broadband Internet service.

The FCC’s final rule by Report and Order adopted on January 22, 2024  concerning “digital discrimination” (the Order) constitutes a significant change to an economic policy. Broadband alone is a $112 billion industry with over 125 million customers. If permitted to stand, the FCC’s broad Order will be harmful to the dynamic marketplace for broadband that presently exists in the United States.

The Information Technology and Innovation Foundation (“ITIF”) is an independent non-profit, non-partisan think tank. ITIF’s mission is to formulate, evaluate, and promote policy solutions that accelerate innovation and boost productivity to spur growth, opportunity, and progress. To that end, ITIF strives to provide policymakers around the world with high-quality information, analysis, and recommendations they can trust. ITIF adheres to the highest standards of research integrity, guided by an internal code of ethics grounded in analytical rigor, policy pragmatism, and independence from external direction or bias.

ITIF’s mission is to advance public policies that accelerate the progress of technological innovation. ITIF believes that innovation can almost always be a force for good. It is the major driver of human advancement and the essential means for improving societal welfare. A robust rate of innovation makes it possible to achieve many other goals—including increases in median per-capita income, improved health, transportation mobility, and a cleaner environment. ITIF engages in policy and legal debates, both directly and indirectly, by presenting policymakers, courts, and other policy influencers with compelling data, analysis, arguments, and proposals to advance effective innovation policies and oppose counterproductive ones.

The FCC’s Order will have a significant impact on the speed and adoption of technological innovation in the United States. The Order not only raises the cost of deployment investments, but it also increases the risk of liability for discrimination, thereby increasing the uncertainty of the investments’ returns. As a result, the Order will not only stifle new deployment to unserved areas, but also will delay network upgrades and maintenance out of fear of alleged disparate effects.

Pursuant to Federal Rule of Appellate Procedure 29(a)(2), ICLE and ITIF have obtained consent of the parties to file the instant Brief of the International Center for Law & Economics and the Information Technology and Innovation Foundation as Amici Curiae In Support of Petitioners.

INTRODUCTION AND SUMMARY OF ARGUMENT

The present marketplace for broadband in the United States is dynamic and generally serves consumers well. See Geoffrey A. Manne, Kristian Stout, & Ben Sperry, A Dynamic Analysis of Broadband Competition: What Concentration Numbers Fail to Capture (ICLE White Paper, Jun. 2021), https://laweconcenter.org/wp-content/uploads/2021/06/A-Dynamic-Analysis-of-Broadband-Competition.pdf. Broadband providers acting in the marketplace have invested $2.1 trillion in building, maintaining, and improving their networks since 1996, including $102.4 billion in 2022 alone. See USTelecom, 2022 Broadband Capex Report (Sept. 8, 2023), https://www.ustelecom.org/research/2022-broadband-capex/. The FCC’s own data suggests that 91% of Americans have access to high-speed broadband under its new and faster definition. See 2024 706 Report, FCC 24-27, GN Docket No. 22-270, at paras. 20, 22 (Mar. 18, 2024).

Despite this, there are areas in the country, primarily due to low population density, where serving consumers is prohibitively expensive. Moreover, affordability remains a concern for some lower-income groups. To address these concerns, Congress passed the Infrastructure Investment and Jobs Act (IIJA), Pub. L. No. 117-58, 135 Stat. 429, which invested $42.5 billion in building out broadband to rural areas through the Broadband Equity, Access, and Deployment (BEAD) Program, and billions more in the Affordable Connectivity Program (ACP), which provided low-income individuals a $30 per month voucher. Congress’s passage of the IIJA was consistent with sustaining the free and dynamic market for broadband.

In addition, to address concerns that broadband providers could engage in discriminatory behavior in deployment decisions, Section 60506(b) of IIJA requires that “[n]ot later than 2 years after November 15, 2021, the Commission shall adopt final rules to facilitate equal access to broadband internet access services, taking into account the issues of technical and economic feasibility presented by that objective, including… preventing digital discrimination of access based on income level, race, ethnicity, color, religion, or national origin.” Pub. L. No. 117-58, § 60506(b)(1), 135 Stat. 429, 1246.

The FCC adopted the final rule by Report and Order in the Federal Register on January 22, 2024. See 89 Fed. Reg. 4128 (Jan. 22, 2024) [hereinafter “Order”] attached as the Addendum to Petitioners’ Brief (“Pet. Add.”). But the digital discrimination rule issued in this Order is inconsistent with the IIJA, so expansive as to claim regulatory authority over major political and economic questions, and is arbitrary and capricious. As a result, this Court must vacate it.

The FCC could have issued a final rule consistent with the statute and the dynamic broadband marketplace. Such a rule would have recognized the limited purpose of the statute was to outlaw intentional discrimination by broadband providers in deployment decisions, in a way that would treat a person or group of persons less favorably than others because of a listed protected trait. This rule would be workable, leaving the FCC to focus its attention on cases where broadband providers fail to invest in deploying networks due to animus against those groups.

Instead, the FCC chose to create an expansive regulatory scheme that gives it essentially unlimited discretion over anything that would affect the adoption of broadband. It did this by adopting a differential impact standard that applies not only to broadband providers, but to anyone that could “otherwise affect consumer access to broadband internet access service,” see 47 CFR §16.2 (definition of “Covered entity”), which includes considerations of price among the “comparable terms and conditions.” See Pet. Add. 59, Order at para. 111 (“Indeed, pricing is often the most important term that consumers consider when purchasing goods and services… this is no less true with respect to broadband internet access services.”). Taken together, these departures from the text of Section 60506 would give the FCC nearly unlimited authority over broadband providers, and even a great deal of authority over other entities that can affect broadband access.

To interpret Section 60506 to encompass a “differential impact” standard, as the agency has done here, leads to a situation in which covered entities that have no intent to discriminate or even take active measures to help protected classes could still be found in violation of the rules. This standard opens nearly everything to FCC review because of the correlation of profit-maximizing motivations not covered by the statute with things that are covered by the statute.

Income level, race, ethnicity, color, religion, and national origin are often incidentally associated with some other non-protected factor important for investment decisions. Specifically, population density is widely recognized as one of the determinants of expected profitability for broadband deployment. See Eric Fruits & Kristian Stout, The Income Conundrum: Intent and Effects Analysis of Digital Discrimination (ICLE Issue Brief 2022-11-14) available at https://laweconcenter.org/wp-content/uploads/2022/11/The-Income-Conundrum-Intent-and-Effects-Analysis-of-Digital-Discrimination.pdf citing U.S. Gov’t Accountability Office, GAO-06-426, Telecommunications Broadband Deployment Is Extensive Throughout the United States, but It Is Difficult to Assess the Extent of Deployment Gaps in Rural Areas 19 (2006) (population density is the “most frequently cited cost factor affecting broadband deployment” and “a critical determinant of companies’ deployment decisions”). But population density is also correlated with income level, with higher density associated with higher incomes. See Daniel Hummel, The Effects of Population and Housing Density in Urban Areas on Income in the United States, 35 Loc. Econ. 27, Feb. 7, 2020, (showing statistically significant positive relationship between income and both population and housing density). Higher population density is also correlated with greater racial, ethnic, religious, and national origin diversity. See, e.g., Barrett A. Lee & Gregory Sharp, Diversity Across the Rural-Urban Continuum, 672 Annals Am. Acad. Pol. & Soc. Sci. 26 (2017).

Consider a hypothetical provider who eschews discrimination against any of the protected traits in its deployment practices by prioritizing its investments solely on population density, deploying to high-density areas first then lower-density areas later. If higher-density areas are also areas with higher incomes, then it would be relatively easy to produce a statistical analysis showing that lower-income areas are associated with lower rates of deployment. Similarly, because of the relationships between population density and race, ethnicity, color, religion, and national origin, it would be relatively easy to produce a statistical analysis showing disparate impacts across these protected traits.

With so many possible spurious correlations, it is almost impossible for any covered entity to know with any certainty whether its policies or practices could be actionable for differential impacts. Nobel laureate, Ronald Coase, is reported to have said, “If you torture the data long enough, it will confess.” Garson O’Toole, If You Torture the Data Long Enough, It Will Confess, Quote Investigator (Jan. 18, 2021), https://quoteinvestigator.com/2021/01/18/confess. The FCC’s Order amounts to an open invitation to torture the data.

While it is possible that the FCC could determine that the costs of deployment due to population density or another profit-relevant reason go to “technical or economic feasibility,” the burden to prove infeasibility are on the covered entity by a preponderance of the evidence standard. See 47 CFR §16.5(c)-(d). This may include “proof that available, less discriminatory alternatives were not reasonably achievable.” See 47 CFR §16.5(c). In its case-by-case review process, there is no guarantee that the Commission will agree that “technical or economic feasibility” warrants an exception in any given dispute. See 47 CFR §16.5(e). This rule will put a great deal of pressure on covered entities to avoid possible litigation by getting all plans pre-approved by the FCC through its advisory opinion authority. See 47 CFR §16.7. This sets up the FCC to be a central planner for nearly everything related to broadband, from deployment to policies and practices that affect even adoption itself, including price of the service. This is inconsistent with preserving the ability of businesses to make “practical business choices and profit-related decisions that sustain a vibrant and dynamic free-enterprise system.” Texas Dep’t of Hous. & Cmty. Affs. v. Inclusive Communities Project, Inc., 576 U.S. 519, 533 (2015). The Order will thus dampen investment incentives because “the specter of disparate-impact litigation” will cause private broadband providers to “no longer construct or renovate” their networks, leading to a situation where the FCC’s rule “undermines its own purpose” under the IIJA “as well as the free market system.” Id. at 544.

ARGUMENT

The FCC’s Order is unlawful. First, the Order’s interpretation of Section 60506 is inconsistent with the structure of the IIJA. Second, the Order is inconsistent with the clear meaning of Section 60506. Third, the Order raises major questions of political and economic significance by giving the FCC nearly unlimited authority over broadband deployment decisions, including price. Fourth, the Order is arbitrary and capricious because it fails to adopt a rule that is reasonable insofar as it will end up reducing investment incentives of broadband providers to deploy and improve broadband service, which is inconsistent with the purpose of the IIJA. Finally, the Order’s vagueness leaves a person of ordinary intelligence no ability to know whether they are subject to the law and thus gives the FCC the ability to engage in arbitrary and discriminatory enforcement.

I. The Order’s Interpretation of Section 60506 Is Inconsistent with the Structure of the IIJA

“It is a fundamental canon of statutory construction that the words of a statute must be read in their context and with a view to their place in the overall statutory scheme.” Davis v. Michigan Dept. of Treasury, 489 U.S. 803, 809 (1989). The structure of the IIJA as a whole, as well as the fact that Section 60506, in particular, was not placed within the larger Communications Act (47 U.S.C. §150 et seq.) that gives the FCC authority, suggests that the Order claims authority far beyond what Congress has granted the FCC.

The IIJA divided broadband policy priorities between different agencies and circumscribes the scope of each program or rulemaking it delegates to agencies. Section 60102 addressed the issue of universal broadband deployment by creating the Broadband Equity, Access, and Deployment (BEAD) Program. See IIJA §60102. The statute designated the National Telecommunication and Information Administration (NTIA) to administer this $42.45 billion program with funds to be first allocated to deploy broadband service to all areas that currently lack access to high-speed broadband Internet. See IIJA §60102(b), (h). BEAD is, therefore, Congress’s chosen method to remedy disparities in broadband deployment due to cost-based barriers like low population density. Section 60502 then created the Affordable Connectivity Program (ACP), which provided low-income individuals a $30 per month voucher, and delegated its administration to the FCC. See IIJA §60502. ACP is, therefore, Congress’s chosen method to remedy broadband affordability for households whose low income is a barrier to broadband adoption. Title V of Division F of the IIJA goes on to create several more broadband programs, each with a specific and limited scope. See IIJA § 60101 et seq.

In short, Congress was intentional about circumscribing the different problems with broadband deployment and access, as well as the scope of the programs it designed to fix them. Section 60506’s authorization for the FCC to prevent “digital discrimination” fits neatly into this statutory scheme if it targets disparate treatment in deployment decisions based upon protected status—i.e., intentional harmful actions that are distinct from deployment decisions based on costs of deployment or projected demand for broadband service. But the FCC’s Order vastly exceeds this statutory scope and claims authority over virtually every aspect of the broadband marketplace, including infrastructure deployment decisions due to cost generally and the potential market for the networks once deployed.  Indeed, the FCC envisions scenarios in which its rules conflict with other federal funding programs but nevertheless says that compliance with them is no safe harbor from liability for disparate impacts that compliance creates. See Pet. Add. 69-70, Order at para. 142. The Order thus dramatically exceeds the boundaries Congress set in Section 60506. Congress cannot have meant for section 60506 to remedy all deployment disparities or all issues of affordability because it created BEAD and ACP for those purposes.

Moreover, Section 60506 was not incorporated into the Communications Act, unlike other parts of the IIJA. In other words, the FCC’s general enforcement authority doesn’t apply to the regulatory scheme of Section 60506. The IIJA was not meant to give the FCC vast authority over broadband deployment and adoption by implication. The FCC must rely on Section 60506 alone for any authority it was given to combat digital discrimination.

II. The Order Is Inconsistent with the Clear Meaning of the Text of Section 60506

The text of Section 60506 plainly shows that the intention of Congress to combat digital discrimination was through the use of circumscribed rules aimed at preventing intentional discrimination in deployment decisions by broadband providers. The statute starts with a statement of policy in part (a) and then gives the Commission direction to fulfill that purpose in parts (b) and (c).

The statement of policy in Section 60506(a) is exactly that: a statement of policy. Courts have long held that statutory sections like Section 60506(a)(1) and (a)(3) using words like “should” are “precatory.” See Emergency Coal. to Def. Educ. Travel v. U.S. Dep’t of Treasury, 498 F. Supp. 2d 150, 165 (D.D.C. 2007) (“Courts have repeatedly held that such ‘sense of Congress’ language is merely precatory and non-binding.”), aff’d, 545 F.3d 4 (D.C. Cir. 2008). While the statement of policy helps illuminate the goal of the provision at issue, it does not actually give the FCC authority. The goal of the statute is clear: to make sure the Commission prevents intentional discrimination in deployment decisions. For instance, Section 60506(c) empowers the Commission (and the Attorney General) to ensure federal policies promote equal access by prohibiting intentional deployment discrimination. See Section 60506(c) (“The Commission and the Attorney General shall ensure that Federal policies promote equal access to robust broadband internet access service by prohibiting deployment discrimination…”). Moreover, the definition of equal access as “equal opportunity to subscribe,” see 47 U.S.C. §1754(a)(2), does not imply a disparate impact analysis. See Brnovich v. Democratic Nat’l Comm., 141 S. Ct. 2321, 2339 (2021) (“[T]he mere fact there is some disparity in impact does not necessarily mean… that it does not give everyone an equal opportunity.”)

There is no evidence that IIJA’s drafters intended the law to be read as broadly as the Commission has done in its rules. The legislative record on Section 60506 is exceedingly sparse, containing almost no discussion of the provision beyond assertions that “broadband ought to be available to all Americans,” 167 Cong. Rec. 6046 (2021), and also that the IIJA was not to be used as a basis for the “regulation of internet rates.”167 Cong. Rec. 6053 (2021). The FCC argues that since “there is little evidence in the legislative history… that impediments to broadband internet access service are the result of intentional discrimination,” Congress must have desired a disparate impact standard. See Pet. Add. 25, Order at para. 47. But the limited nature of the problem suggests a limited solution in the form of a framework aimed at preventing such discrimination. Given the sparse evidence on legislative intent, Section 60506 should be read as granting a limited authority to the Commission.

With Section 60506(b), Congress gave the Commission a set of tools to identify and remedy acts of intentional discrimination by broadband providers in deployment decisions. As we explain below, under both the text of Section 60506 and the Supreme Court’s established jurisprudence, the Commission was not empowered to employ a disparate-impact (or “differential impact”) analysis under its digital discrimination rules.

Among the primary justifications for disparate-impact analysis is to remedy historical patterns of de jure segregation that left an indelible mark on minority communities. See Inclusive Communities, 576 at 528-29. While racial discrimination has not been purged from society, broadband only became prominent in the United States well after all forms of de jure segregation were made illegal, and after Congress and the courts had invested decades in rooting out impermissible de facto discrimination. In enacting its rules that give it presumptive authority over nearly all decisions related to broadband deployment and adoption, the FCC failed to adequately take this history into account.

Beyond the policy questions, however, Section 60506 cannot be reasonably construed as authorizing disparate-impact analysis. While the Supreme Court has allowed disparate-impact analysis in the context of civil-rights law, it has imposed some important limitations. To find disparate impact, the statute must be explicitly directed “to the consequences of an action rather than the actor’s intent.”  Inclusive Communities., 576 U.S. at 534. There, the Fair Housing Act made it unlawful:

To refuse to sell or rent after the making of a bona fide offer, or to refuse to negotiate for the sale or rental of, or otherwise make unavailable or deny, a dwelling to any person because of race, color, religion, sex, familial status, or national origin.

42 U.S.C. §3604(a) (emphasis added). The Court noted that the presence of language like “otherwise make unavailable” is critical to construing a statute as demanding an effects-based analysis. Inclusive Communities., 576 U.S. at 534. Such phrases, the Court found, “refer[] to the consequences of an action rather than the actor’s intent.” Id. Further, the structure of a statute’s language matters:

The relevant statutory phrases… play an identical role in the structure common to all three statutes: Located at the end of lengthy sentences that begin with prohibitions on disparate treatment, they serve as catchall phrases looking to consequences, not intent. And all [of these] statutes use the word “otherwise” to introduce the results-oriented phrase. “Otherwise” means “in a different way or manner,” thus signaling a shift in emphasis from an actor’s intent to the consequences of his actions.

Id. at 534-35.

Previous Court opinions help parse the distinction between statutes limited to intentional discrimination claims and those that allow for disparate impact claims. Particularly relevant here, the Court looked at language from Section 601 of the Civil Rights Act stating that “[n]o person in the United States shall, on the ground of race, color, or national origin, be excluded from participation in, be denied the benefits of, or be subjected to discrimination under any program or activity receiving Federal financial assistance,” 42 U.S.C. §2000d (emphasis added), and found it “beyond dispute—and no party disagrees—that [it] prohibits only intentional discrimination.”  Alexander v. Sandoval, 532 U.S. 275, 280 (2001).

Here, the language of Section 60506” (“based on”) mirrors the language of Section 601 of the Civil Rights Act (“on the ground of”). Moreover, it is consistent with the reasoning of Inclusive Communities that determines when a statute allows for disparate impact analysis. Inclusive Communities primarily based its opinion on the “otherwise make unavailable” language at issue, with a particular focus on “otherwise” creating a more open-ended inquiry. See Inclusive Communities, 576 U.S. at 534 (“Here, the phrase ‘otherwise make unavailable’ is of central importance to the analysis that follows”). Such language is absent in Section 60506. Moreover, the closest analogy for Section 60506’s “based on” language is the “on the ground of” language of Title VI of the Civil Rights Act, which also does not include the “otherwise” language found to be so important in Inclusive Communities. Compare 42 U.S.C. §2000d with Inclusive Communities, 576 U.S. at 534-35 (focusing on how “otherwise” is a catch-all phrase looking to consequences instead of intent). If the Court has found “grounded on” means only intentional discrimination, then it is hard to see how “based on” wouldn’t lead to the same conclusion.

Thus, since Section 60506 was drafted without “results-oriented language” and instead frames the prohibition against digital discrimination as “based on income level, race, ethnicity, color, religion, or national origin,” this would put the rule squarely within the realm of prohibitions on intentional discrimination. That is, to be discriminatory, the decision to deploy or not to deploy must have been intentionally made based on or grounded on the protected characteristic. Mere statistical correlation between deployment and protected characteristics is insufficient.

In enacting the IIJA, Congress was undoubtedly aware of the Court’s history with disparate-impact analysis. Had it chosen to do so, it could have made the requirements of Section 60506 align with the requirements of that precedent. But it chose not to do so.

III. Congress Did Not Clearly Authorize the FCC to Decide a Major Question in this Order

To read Section 60506 of the IIJA as broadly as the FCC does in the Order invites a challenge under the major-questions doctrine. There are “extraordinary cases” where the “history and the breadth of the authority” that an agency asserts and the “economic and political significance” of that asserted authority provide “reason to hesitate before concluding that Congress” meant to confer such authority. See West Virginia v. EPA, 597 U.S. 697, 721 (2022) (quoting FDA v. Brown & Williamson, 529 U.S. 120, 159-60 (2000)). In such cases, “something more than a merely plausible textual basis for agency action is necessary. The agency instead must point to ‘clear congressional authorization’ for the power it claims.” Id. at 723 (quoting Utility Air Regulatory Group v. EPA, 573 U.S. 302, 324 (2014).

Here, the FCC has claimed dramatic new powers over the deployment of broadband Internet access, and it has exercised that alleged authority to create a process for inquiry into generalized civil rights claims. Such a system is as unprecedented as it is important to the political and economic environment of the country. The FCC itself implicitly recognizes this fact when it emphasizes the critical importance of Internet access as necessary “to meet basic needs.” Broadband alone is a $112 billion industry with over 125 million customers. See The History of US Broadband, S&P Global (last accessed May 11, 2023), https://www.spglobal.com/marketintelligence/en/news-insights/research/the-history-of-us-broadband. This doesn’t even include all the entities covered by this Order, which also includes all those who could “otherwise affect consumer access to broadband internet access service.” See 47 CFR §16.2. There is, therefore, no doubt that the Order is of great economic and political significance.

This would be fine if the statute clearly delegated such power to the FCC. But the only potential source of authority for the Order is Section 60506. Since the text of Section 60506 can be (and is better) read as not giving the FCC such authority, it simply can’t be an unambiguous delegation of authority.

As argued above, Congress knows how to write a disparate-impact statute in light of Supreme Court jurisprudence. Put simply, Congress did not write a disparate-impact statute here because there is no catch-all language comparable to what the Supreme Court has pointed to in statutes like the FHA. Cf. Inclusive Communities, 576 U.S. at 533 (finding a statute includes disparate-impact liability when the “text refers to the consequences of actions and not just the mindset of actors”). At best, Section 60506 is ambiguous in giving the authority to the FCC to use disparate impact analysis. That is simply not enough when regulating an area of great economic and political significance.

In addition to the major question of whether the FCC may enact its vast disparate impact apparatus, the FCC claims vast authority over the economically and politically significant arena of broadband rates despite no clear authorization to do so in Section 60506. In fact, in the legislative record, Congress explicitly wanted to avoid the possibility that the IIJA would be used as the basis for the “regulation of internet rates.” 167 Cong. Rec. 6053 (2021). The FCC disclaims the authority to engage in rate regulation, but it does claim authority for “ensuring pricing consistency.” See Pet. Add. 56-57, Order at para. 105. While the act of assessing the comparability of prices is not rate regulation in the sense that the Communications Act contemplates, a policy that holds entities liable for those disparities such that an ISP must adjust its prices until it matches an FCC definition of “comparable” is tantamount to setting that rate. See Eric Fruits & Geoffrey Manne, Quack Attack: De Facto Rate Regulation in Telecommunications (ICLE Issue Brief 2023-03-30), available at https://laweconcenter.org/wp-content/uploads/2023/03/De-Facto-Rate-Reg-Final-1.pdf (describing how the FCC often engages in rate regulation in practice even when it doesn’t call it that).

Furthermore, the Order could also allow the FCC to use the rule to demand higher service quality under the “comparable terms and conditions” language, even if consumers may prefer lower speeds for less money. That increased quality comes at a cost that will necessarily increase the market price of broadband. In this way, the Order would allow the FCC to set a price floor even if it never explicitly requires ISPs to submit their rates for approval.

The elephant of rate regulation is not hiding in the mousehole of Section 60506. Cf. Whitman v. American Trucking Assns., Inc., 531 U.S. 457, 468 (2001). Indeed, the FCC itself forswears rate regulation in an ongoing proceeding in which the relevant statute would clearly authorize it. See Safeguarding and Securing the Open Internet, 88 Fed. Reg. 76048 (proposed Nov. 3, 2023) (to be codified at 47 CFR pts. 8, 20). Nevertheless, the FCC recognized that rate regulation is inappropriate for the broadband marketplace and has declined its application in that proceeding. Even here, the FCC has denied that including pricing within the scope of the rules is “an attempt to institute rate regulation.” See Pet. Add. 59, Order at para. 111. But despite its denials, the FCC’s claim of authority would allow it to regulate prices despite nothing in Section 60506 granting it authority to do so. The FCC should not be able to recognize a politically significant consensus against rate regulation one minute and then smuggle that disfavored policy in through a statute that never mentions it the next.

Finally, as noted above, since many of the protected characteristics, but especially income, can be correlated with many factors relevant to profitability, it would be no surprise that almost any policy or practice of a covered entity under the Order could be subject to FCC enforcement. And since there is no guarantee that the FCC would agree in a particular case that technical or economic feasibility justifies a particular policy or practice, nearly everything a broadband provider or other covered entities do would likely need pre-approval under the FCC’s advisory opinion process. This would essentially make the FCC a central planner of everything related to broadband. In other words, the FCC has clearly claimed authority far beyond what Congress could have imagined without any clear authorization to do so.

IV. The Order Is Arbitrary and Capricious Because It Will Produce Results Inconsistent with the Purpose of the Statute

As noted above, the purposes of the broadband provisions of the IIJA are to encourage broadband deployment, enhance broadband affordability, and prevent discrimination in broadband access. Put simply, the purpose is to get more Americans to adopt more broadband, regardless of income level, race, ethnicity, color, religion, or national origin. The FCC’s Order should curtail discrimination, but the aggressive and expansive police powers the agency grants itself will surely diminish investments in broadband deployment and efforts to encourage adoption. We urge the Court to vacate the Order and require the FCC to adopt rules limited to preventing intentional discrimination in deployment by broadband Internet access service providers. More narrowly tailored rules would satisfy Section 60506’s mandates while preserving incentives to invest in deployment and encourage adoption. Cf. Cin. Bell Tel. Co. v. FCC, 69 F.3d 752, 761 (6th Cir. 1995) (“The FCC is required to give [a reasoned] explanation when it declines to adopt less restrictive measures in promulgating its rules.”). But the current Order is arbitrary and capricious because the predictable results of the rules would be inconsistent with the purpose of the IIJA in promoting broadband deployment. See Motor Vehicle Mfrs. Ass’n v. State Farm Mutual Auto. Ins. Co., 463 U.S. 29, 43 (1983) (“[A]n agency rule would be arbitrary and capricious if the agency has… offered an explanation for its decision that runs counter to the evidence before the agency, or is so implausible that it could not be ascribed to a difference in view of the product of agency expertise”).

The Order spans nearly every aspect of broadband deployment, including, but not limited to network infrastructure deployment, network reliability, network upgrades, and network maintenance. Pet. Add. 58, Order ¶ 108. In addition, the Order covers a wide range of policies and practices that while not directly related to deployment, affect the profitability of deployment investments, such as pricing, discounts, credit checks, marketing or advertising, service suspension, and account termination. Pet. Add. 58, Order ¶ 108.

Like all firms, broadband providers have limited resources with which to make their investments. While profitability (i.e., economic feasibility) is a necessary precondition for investment, not all profitable investments can be undertaken. Among the universe of economically feasible projects, firms are likely to give priority to those that promise greater returns on investment relative to those with lower returns. Returns on investment in broadband depend on several factors. Population density, terrain, regulations, and taxes are all important cost factors, while a given consumer population’s willingness to adopt and pay for broadband are key demand-related factors. Anything that raises the cost of expected cost deployment or reduces the demand for service can turn a profitable investment into an unprofitable prospect or downgrade its priority relative to other investment opportunities.

The Order not only raises the cost of deployment investments, but it also increases the risk of liability for discrimination, thereby increasing the uncertainty of the investments’ returns. Because of the well-known and widely accepted risk-return tradeoff, firms that face increased uncertainty in investment returns will demand higher expected returns from the investments they pursue. This demand for higher returns means that some projects that would have been pursued under more limited digital discrimination rules will not be pursued under the current Order.

The Order will not only stifle new deployment to unserved areas, but also will delay network upgrades and maintenance out of fear of alleged disparate effects. At the extreme, providers will be faced with the choice to upgrade everyone or upgrade no one. Because they cannot afford to upgrade everyone, then they will upgrade no one.

It might be argued that providers could avoid some of the ex post regulatory risk by ex ante seeking pre-approval under the FCC’s advisory opinion process. Such processes are costly and are not certain to result in approval. Even if approved, the FCC reserves to right to rescind the pre-approval. See Pet. Add. 75, Order ¶ 156 (“[A]dvisory opinions will be issued without prejudice to the Enforcement Bureau’s or the Commission’s ability to reconsider the questions involved, and rescind the opinion. Because advisory opinions would be issued by the Enforcement Bureau, they would also be issued without prejudice to the Commission’s right to later rescind or revoke the findings.”). Under the Order’s informal complaint procedures, third parties can allege discriminatory effects associated with pre-approved policies and practices that could result in the recission of pre-approval. The result is an unambiguous increase in deployment and operating costs, even with pre-approval.

Moreover, by imposing liability for disparate impacts outside the control of covered broadband providers, the Order produces results inconsistent with the purpose of the IIJA because parties cannot conform their conduct to the rules. Among the 7% of households who do not use the internet at home, more than half of Current Population Survey (CPS) respondents indicated that they “don’t need it or [are] not interested.” George S. Ford, Confusing Relevance and Price: Interpreting and Improving Surveys on Internet Non-adoption, 45 Telecomm. Pol’y, Mar. 2021. ISPs sell broadband service, but they cannot force uninterested people to buy their product.

Only 2-3% of U.S. households that have not adopted at-home broadband indicate it is because of a lack of access. Eric Fruits & Geoffrey Manne, Quack Attack: De Facto Rate Regulation in Telecommunications (ICLE Issue Brief 2023-03-30) at Table 1, available at https://laweconcenter.org/wp-content/uploads/2023/03/De-Facto-Rate-Reg-Final-1.pdf. And even this tiny fraction is driven by factors such as topography, population density, and projected consumer demand. Differences in these factors will be linked to differences in broadband deployment, but there is little that an ISP can do to change them. If the FCC’s command could make the mountainous regions into flat plains, it would have done so already. It is nonsensical to hold liable a company attempting to overcome obstacles to deployment because they do not do so simultaneously everywhere. And it is not a rational course of action to address a digital divide by imposing liability on entities that cannot fix the underlying causes driving it.

Punishment exacted on an ISP will not produce the broadband access the statute envisions for all Americans. In fact, it will put that access further out of reach by incentivizing ISPs to reduce the speed of deployments and upgrades so that they do not produce inadvertent statistical disparities. Given the statute’s objective of enhancing broadband access, the FCC’s rulemaking must contain a process for achieving greater access. The Order does the opposite and, therefore, cannot be what Congress intended. Cf. Inclusive Communities, 576 U.S. at 544 (“If the specter of disparate-impact litigation causes private developers to no longer construct or renovate housing units for low-income individuals, then the FHA would have undermined its own purpose as well as the free-market system.”).

The Order will result in less broadband investment by essentially making the FCC the central planner of all deployment and pricing decisions. This is inconsistent with the purpose of Section 60506, making the rule arbitrary and capricious.

V. The Order’s Vagueness Gives the FCC Unbounded Power

The Order’s digital discrimination rule is vague because it does not have “sufficient definiteness that ordinary people can understand what conduct is prohibited.” Kolender v. Lawson, 461 U.S. 352, 357 (1983). As a result, the FCC has claimed unbounded power to engage in “arbitrary and discriminatory enforcement.” Id. As argued above, the disparate impact standard means that anything that is correlated with income, which includes many things that may be benignly relevant to deployment and pricing decisions, could give rise to a possible violation of the Order.

While a covered entity could argue that there are economic or technical feasibility reasons for a policy or practice, the case-by-case nature of enforcement outlined in the Order means that no one can be sure of whether they are on the right side of the law. See 47 CFR §16.5(e) (“The Commission will determine on a case-by-case basis whether genuine issues of technical or economic feasibility justified the adoption, implementation, or utilization of a [barred] policy or practice…”).

This vagueness is not cured by the presence of the Order’s advisory opinion process because the FCC retains the right to bring an enforcement action anyway after reconsidering, rescinding, or revoking it. See 47 CFR §16.5(e) (“An advisory opinion states only the enforcement intention of the Enforcement Bureau as of the date of the opinion, and it is not binding on any party. Advisory opinions will be issued without prejudice to the Enforcement Bureau or the Commission to reconsider the questions involved, or to rescind or revoke the opinion. Advisory opinions will not be subject to appeal or further review”). In other words, there is no basis for concluding a covered entity has “the ability to clarify the meaning of the regulation by its own inquiry, or by resort to an administrative process.” Cf. Village of Hoffman Estates v. Flipside, Hoffman Estates, Inc., 455 U.S. 489, 498 (1982). The FCC may engage in utterly arbitrary and discriminatory enforcement under the Order.

Moreover, the Order’s expansive definition of covered entities to include any “entities that provide services that facilitate and affect consumer access to broadband internet access service,” 47 CFR § 16.2 (definition of “Covered entity”, which includes “Entities that otherwise affect consumer access to broadband internet access service”), also leads to vagueness as to whom the digital discrimination rules apply. This would arguably include state and local governments and nonprofits, as well as multi-family housing owners, many of whom may have no idea they are subject to the FCC’s digital discrimination rules nor any idea of how to comply.

The Order is therefore void for vagueness because it does not allow a person of ordinary intelligence to know whether they are complying with the law and gives the FCC nearly unlimited enforcement authority.

CONCLUSION

For the foregoing reasons, ICLE and ITIF urge the Court to set aside the FCC’s Order.

Introduction and Summary of Argument

The Sherman Act is the “Magna Carta of free enterprise.” Verizon Commcn’s Inc. v. Law Offs. of Curtis V. Trinko, LLP, 540 U.S. 398, 415 (2004) (citation omitted). It directs itself “not against conduct which is competitive, even severely so, but against conduct which unfairly tends to destroy competition itself.” Spectrum Sports, Inc. v. McQuillan, 506 U.S. 447, 458 (1993). And it does so not to protect corporate or private interests, but from concern for consumer welfare and the public interest. Id. The goal of antitrust law thus “is not to redress losers of legitimate competition; [i]t is to proscribe actions with anticompetitive effect.” Apartments Nationwide, Inc. v. Harmon Publ’g Co., 78 F.3d 584 (6th Cir. 1996) (table); Omega Env’t, Inc. v. Gilbarco, Inc., 127 F.3d 1157, 1163 (9th Cir. 1997) (“[T]he antitrust laws were not designed to equip [a] competitor with [its rival’s] legitimate competitive advantage.”).

For almost four decades, CoStar Group, Inc. and CoStar Realty Information, Inc. (“CoStar”) have provided commercial real estate
(“CRE”) services, including CRE listings and auction services. Commercial Real Estate Exchange Inc. (“CREXi”), launched almost a decade ago, is attempting to build its own CRE platform. CoStar filed suit against CREXi in September 2020, alleging that CREXi “harvests content, including broker directories, from CoStar’s subscription database without authorization by using passwords issued to other companies.” See Dist. Ct. Dkt. 1. In response, CREXi filed eight antitrust counterclaims for violations of the Sherman Act (seven claims) and the Cartwright Act (one claim). Dist. Ct. Dkt. 146. The district court dismissed them all.

In asking this Court to reverse the district court’s decision, CREXi and its amicus make three critical errors. First, CREXi and the FTC try to recast the court’s analysis as incorrectly applying a “refusal-to-deal framework.” Doc. 24 (“FTC Br.”) 10; Doc. 21 (“CREXi Br.”) 32. But the district court did not apply any such framework. Nor did it borrow any of the elements this Court has found must be pleaded in refusal to deal cases. See FTC v. Qualcomm Inc., 969 F.3d 974, 994–95 (9th Cir. 2020). Instead, the court did what courts do when considering antitrust claims—analyze contractual language and market realities in light of the bedrock antitrust principle that “a business generally has the right to refuse to deal with its competitors.” Dist. Ct. Dkt. 340 (“Op.”) 3. There is nothing improper about analyzing antitrust claims against the backdrop of this (and other) “traditional antitrust principles.” Trinko, 540 U.S. at 411.

Second, CREXi and the FTC argue that CoStar’s contractual provisions with brokers are “de facto” exclusivity provisions that violate the Sherman Act. CREXi Br. 62–64; FTC Br. 17–19. Yet both fail to acknowledge that this Court has never “explicitly recognized a ‘de facto’ exclusive dealing theory.” Aerotec Int’l, Inc. v. Honeywell Int’l, Inc., 836 F.3d 1171, 1182 (9th Cir. 2016). A careful examination of this theory reveals that it lacks a doctrinal foundation, and that this Court’s cases, historical context, and administrability concerns all counsel strongly against recognizing this theory. In any event, even if this were a viable theory, it is unavailable to CREXi here because CoStar’s express contractual terms plainly do not “substantially foreclose[]” brokers from dealing with CREXi. Id.

Third, CREXi and the FTC both urge this Court to hold that allegations of supracompetitive prices alone are enough to adequately allege direct evidence of market power, and thus that the test applied in Rebel Oil Co., Inc. v. Atl. Richfield Co., 51 F.3d 1421, 1433 (9th Cir. 1995), is “wrong as a matter of law.” CREXi Br. 38. Not so. Direct evidence of market power is “only rarely available.” United States v. Microsoft Corp., 253 F.3d 34, 51 (D.C. Cir. 2001) (en banc) (per curiam). And as the Supreme Court has made clear, market power is “the ability to raise prices profitably by restricting output. Ohio v. Am. Express Co., 138 S. Ct. 2274, 2288 (2018) (quoting Areeda & Hovenkamp § 5.01) (emphasis in original). “[H]igh price alone” thus is not enough to infer market power. Coal. for ICANN Transparency, Inc. v. VeriSign, Inc., 611 F.3d 495, 503 (9th Cir. 2010); see Blue Cross & Blue Shield United of Wis. v. Marshfield Clinic, 65 F.3d 1406, 1412 (7th Cir. 1995) (Posner, J.). A plaintiff seeking to present direct evidence of market power needs to show more than prices above a competitive level. It must show “evidence of restricted output and supracompetitive prices.” Rebel Oil, 51 F.3d at 1434 (emphasis added); Forsyth v. Humana, Inc., 114 F.3d 1467, 1476 (9th Cir. 1997) (“With no accompanying showing of restricted output,” “hig[h] prices” and “high profits … fail[ ] to present direct evidence of market power.”), overruled on other grounds by Lacey v. Maricopa Cnty, 693 F.3d 896 (9th Cir. 2012).

The arguments pushed by CREXi and the FTC, if accepted, would open the floodgates to baseless antitrust suits. Recognizing claims based on the de facto exclusive dealing theory would allow a competitor to transform its rival’s plainly nonexclusive contractual language into exclusive dealing provisions and drag its rival into expensive, protracted discovery based on speculative allegations about third-party conduct. Indeed, there is no end to what a struggling competitor could do with such an amorphous doctrine. So too, permitting a party to establish direct evidence of market power through allegations of supracompetitive prices alone would contravene binding authority and bedrock antitrust principles.

In rejecting these arguments below, the district court properly concluded that CREXi failed to meet its pleading burden for its antitrust
counterclaims. This Court should affirm.

Read the full brief here.

INTEREST OF AMICI CURIAE

Amici Curiae are 24 former government officials, former judges, and intellectual property scholars who have developed copyright law and policy, researched and written about copyright law, or both. They are concerned about ensuring that copyright law continues to secure both the rights of authors and publishers in creating and disseminating their works and the rights of the public in accessing these works. It is vital for this Court to maintain this balance between creators and the public set forth in the constitutional authorization to Congress to create the copyright laws. Amici have no stake in the parties or in the outcome of the case. The names and affiliations of the members of the Amici are set forth in Addendum A below.[1]

SUMMARY OF ARGUMENT

Copyright fulfills its constitutional purpose to incentivize the creation and dissemination of new works by securing to creators the exclusive rights of reproduction and distribution. 17 U.S.C. § 106. Congress narrowly tailored the exceptions to these rights to avoid undermining the balanced system envisioned by the Framers. See 17 U.S.C. §§ 107–22. As James Madison recognized, the “public good fully coincides . . . with the claims of individuals” in the protection of copyright. The Federalist NO. 43, at 271–72 (James Madison) (Clinton Rossiter ed., 1961). Internet Archive (“IA”) and its amici wrongly frame copyright’s balance of interests as between the incentive to create, on the one hand, and the public good, on the other hand. That is not the balance that copyright envisions.

IA’s position also ignores the key role that publishers serve in the incentives copyright offers to authors and other creators. Few authors, no matter how intellectually driven, will continue to perfect their craft if the economic rewards are insufficient to meet their basic needs. As the Supreme Court observed, “copyright law celebrates the profit motive, recognizing that the incentive to profit from the exploitation of copyrights will redound to the public benefit by resulting in the proliferation of knowledge.” Eldred v. Ashcroft, 537 U.S. 186, 212 n.18 (2003) (quoting Am. Geophysical Union v. Texaco Inc., 802 F. Supp. 1, 27 (S.D.N.Y. 1992)). Accordingly, the Supreme Court and Congress have long recognized that copyright secures the fruits of intermediaries’ labors in their innovative development of distribution mechanisms of authors’ works. Copyright does not judge the value of a book by its cover price. Rather, core copyright policy recognizes that the profit motive drives the willingness ex ante to invest time and resources in creating both copyrighted works and the means to distribute them. In sum, commercialization is fundamental to a functioning copyright system that achieves its constitutional purpose.

IA’s unauthorized reproduction and duplication of complete works runs roughshod over this framework. Its concept of controlled digital lending (CDL) does not fall into any exception—certainly not any conception of fair use recognized by the courts or considered by Congress—and thus violates copyright owners’ exclusive rights. Expanding the fair use doctrine to immunize IA’s wholesale copying would upend Congress’s carefully-considered, repeated rejections of similar proposals.

Hoping to excuse its disregard for copyright law, IA and its amici attempt to turn the fair use analysis on its head. They acknowledge that the first sale exception does not permit CDL, as this Court made clear in Capitol Records, LLC v. ReDigi Inc., 910 F.3d 649 (2d Cir. 2018).[2] They also are aware that courts consistently have rejected variations on the argument that wholesale copying, despite a format shift, is permissible under fair use.[3] Nevertheless, IA and its amici ask this Court, for the first time in history, to create a first sale-style exemption within the fair use analysis. CDL is not the natural evolution of libraries in the digital age; rather, like Frankenstein’s monster, it is an abomination composed of disparate parts of copyright doctrine. If endorsed by this Court, it would undermine the constitutional foundation of copyright jurisprudence and the separation of powers.

The parties and other amici address the specific legal doctrines, as well as the technical and commercial context in which these doctrinal requirements apply in this case, and thus Amici provide additional information on the nature and function of copyright that should inform this Court’s analysis and decision.

First, although IA and its amici argue that there are public benefits to the copying in which IA has engaged that support a finding that CDL is fair use, their arguments ignore that copyright itself promotes the public good and the inevitable harms that would result if copyright owners were unable to enforce their rights against the wholesale, digital distribution of their works by IA.

Second, IA’s assertion of the existence of a so-called “digital first sale” doctrine—a principle that, unlike the actual first sale statute, would permit the reproduction, as well as the distribution, of copyrighted works—is in direct conflict with Congress and the Copyright Office’s repeated study (and rejection) of similar proposals. Physical and digital copies simply are different, and it is not an accident that first sale applies only to the distribution of physical copies. Ignoring decades of research and debate, IA pretends instead that Congress has somehow overlooked digital first sale, yet left it open to the courts to engage in policymaking by shoehorning it into the fair use doctrine. By doing so, IA seeks to thwart the democratic process to gain in the courts what CDL’s proponents have not been able to get from Congress.

Third, given that there is no statutory support for CDL, most libraries offer their patrons access to digital works by entering into licensing agreements with authors and their publishers. Although a minority of libraries have participated in IA’s CDL practice, and a few have filed amicus briefs in support of IA in this Court, the vast majority of libraries steer clear because they recognize that wholesale copying and distribution deters the creation of new works. As author Sandra Cisneros understands: “Real libraries do not do what Internet Archive does.” A-250 (Cisneros Decl.) ¶12. There are innumerable ways of accessing books, none of which require authors and publishers to live in a world where their books are illegally distributed for free.

No court has ever found that reproducing and giving away entire works—en masse, without permission, and without additional comment, criticism, or justification—constitutes fair use. IA’s CDL theory is a fantasy divorced from the Constitution, the laws enacted by Congress, and the longstanding policies that have informed copyright jurisprudence. This Court should reject IA’s effort to erase authors and publishers from the copyright system.

[1] The parties have consented to the filing of this brief. Amici Curiae and their counsel authored this brief. Neither a party, its counsel, nor any person other than Amici and their counsel contributed money that was intended to fund preparing or submitting this brief.

[2] See SPA-38 (“IA accepts that ReDigi forecloses any argument it might have under Section 109(a).”); Dkt. 60, Brief for Defendant-Appellant Internet Archive (hereinafter “IA Br.”) (appealing only the district court’s decision on fair use).

[3] See, e.g., ReDigi, 910 F.3d at 662; UMG Recordings, Inc. v. MP3.com, Inc., 92 F. Supp. 2d 349, 352 (S.D.N.Y. 2000); see also Disney Enters., Inc. v. VidAngel, Inc., 869 F.3d 848, 861–62 (9th Cir. 2017).

Dear Justice Guerrero and Associate Justices,

In accordance with California Rule of Court 8.500(g), we are writing to urge the Court to grant the Petition for Review filed by Petitioner Gilead Sciences, Inc. (“Petitioner” or “Gilead”) on February 21, 2024, in the above-captioned matter.

We agree with Petitioner that the Court of Appeal’s finding of a duty of reasonable care in this case “is such a seismic change in the law and so fundamentally wrong, with such grave consequences, that this Court’s review is imperative.” (Pet. 6.) The unprecedented duty of care put forward by the Court of Appeal—requiring prescription drug manufacturers to exercise reasonable care toward users of a current drug when deciding when to bring a new drug to market (Op. 11)—would have far-reaching, harmful implications for innovation that the Court of Appeal failed properly to weigh.

If upheld, this new duty of care would significantly disincentivize pharmaceutical innovation by allowing juries to second-guess complex scientific and business decisions about which potential drugs to prioritize and when to bring them to market. The threat of massive liability simply for not developing a drug sooner would make companies reluctant to invest the immense resources needed to bring new treatments to patients. Perversely, this would deprive the public of lifesaving and less costly new medicines. And the prospective harm from the Court of Appeal’s decision is not limited only to the pharmaceutical industry.

We urge the Court to grant the Petition for Review and to hold that innovative firms do not owe the users of current products a “duty to innovate” or a “duty to market”—that is, that firms cannot be held liable to users of a current product for development or commercialization decisions on the basis that those decisions could have facilitated the introduction of a less harmful, alternative product.

Interest of Amicus Curiae

The International Center for Law & Economics (“ICLE”) is a nonprofit, non-partisan global research and policy center aimed at building the intellectual foundations for sensible, economically grounded policy. ICLE promotes the use of law and economics methodologies and economic learning to inform policy debates. It also has longstanding expertise in evaluating law and policy relating to innovation and the legal environment facing commercial activity. In this letter, we wish to briefly highlight some of the crucial considerations concerning the effect on innovation incentives that we believe would arise from the Court of Appeal’s ruling in this case.[1]

The Court of Appeal’s Duty of Care Standard Would Impose Liability Without Requiring Actual “Harm”

The Court of Appeal’s ruling marks an unwarranted departure from decades of products-liability law requiring plaintiffs to prove that the product that injured them was defective. Expanding liability to products never even sold is an unprecedented, unprincipled, and dangerous approach to product liability. Plaintiffs’ lawyers may seek to apply this new theory to many other beneficial products, arguing manufacturers should have sold a superior alternative sooner. This would wreak havoc on innovation across industries.

California Civil Code § 1714 does not impose liability for “fail[ing] to take positive steps to benefit others,” (Brown v. USA Taekwondo (2021) 11 Cal.5th 204, 215), and Plaintiffs did not press a theory that the medicine they received was defective. Moreover, the product included all the warnings required by federal and state law. Thus, Plaintiffs’ case—as accepted by the Court of Appeal—is that they consumed a product authorized by the FDA, that they were fully aware of its potential side effects, but maybe they would have had fewer side effects had Gilead made the decision to accelerate (against some indefinite baseline) the development of an alternative medicine. To call this a speculative harm is an understatement, and to dismiss Gilead’s conduct as unreasonable because motivated by a crass profit motive, (Op. at 32), elides many complicated facts that belie such a facile assertion.

A focus on the narrow question of profits for a particular drug misunderstands the inordinate complexity of pharmaceutical development and risks seriously impeding the rate of drug development overall. Doing so

[over-emphasizes] the recapture of “excess” profits on the relatively few highly profitable products without taking into account failures or limping successes experienced on the much larger number of other entries. If profits were held to “reasonable” levels on blockbuster drugs, aggregate profits would almost surely be insufficient to sustain a high rate of technological progress. . . . If in addition developing a blockbuster is riskier than augmenting the assortment of already known molecules, the rate at which important new drugs appear could be retarded significantly. Assuming that important new drugs yield substantial consumers’ surplus untapped by their developers, consumers would lose along with the drug companies. Should a tradeoff be required between modestly excessive prices and profits versus retarded technical progress, it would be better to err on the side of excessive profits. (F. M. Scherer, Pricing, Profits, and Technological Progress in the Pharmaceutical Industry, 7 J. Econ. Persp. 97, 113 (1993)).

Indeed, Plaintiffs’ claim on this ground is essentially self-refuting. If the “superior” product they claim was withheld for “profit” reasons was indeed superior, then Plaintiffs could have expected to make a superior return on that product. Thus, Plaintiffs claim they were allegedly “harmed” by not having access to a product that Petitioners were not yet ready to market, even though Petitioners had every incentive to release a potentially successful alternative as soon as possible, subject to a complex host of scientific and business considerations affecting the timing of that decision.

Related, the Court of Appeal’s decision rests on the unfounded assumption that Petitioner “knew” TAF was safer than TDF after completing Phase I trials. This ignores the realities of the drug development process and the inherent uncertainty of obtaining FDA approval, even after promising early results. Passing Phase I trials, which typically involve a small number of healthy volunteers, is a far cry from having a marketable drug. According to the Biotechnology Innovation Organization, only 7.9% of drugs that enter Phase I trials ultimately obtain FDA approval.[2] (Biotechnology Innovation Organization, Clinical Development Success Rates and Contributing Factors 2011-2020, Fig. 8b (2021), available at https://perma.cc/D7EY-P22Q.) Even after Phase II trials, which assess efficacy and side effects in a larger patient population, the success rate is only about 15.1%. (Id.) Thus, at the time Gilead decided to pause TAF development, it faced significant uncertainty about whether TAF would ever reach the market, let alone ultimately prove safer than TDF.

Moreover, the clock on Petitioner’s patent exclusivity for TAF was ticking throughout the development process. Had Petitioner “known” that TAF was a safer and more effective drug, it would have had every incentive to bring it to market as soon as possible to maximize the period of patent protection and the potential to recoup its investment. The fact that Petitioner instead chose to focus on TDF strongly suggests that it did not have the level of certainty the Court of Appeal attributed to it.

Although conventional wisdom has often held otherwise, economists generally dispute the notion that companies have an incentive to unilaterally suppress innovation for economic gain.

While rumors long have circulated about the suppression of a new technology capable of enabling automobiles to average 100 miles per gallon or some new device capable of generating electric power at a fraction of its current cost, it is rare to uncover cases where a worthwhile technology has been suppressed altogether. (John J. Flynn, Antitrust Policy, Innovation Efficiencies, and the Suppression of Technology, 66 Antitrust L.J. 487, 490 (1998)).

Calling such claims “folklore,” the economists Armen Alchian and William Allen note that, “if such a [technology] did exist, it could be made and sold at a price reflecting the value of [the new technology], a net profit to the owner.” (Armen A. Alchian & William R. Allen, Exchange & Production: Competition, Coordination, & Control (1983), at 292). Indeed, “even a monopolist typically will have an incentive to adopt an unambiguously superior technology.” (Joel M. Cohen and Arthur J. Burke, An Overview of the Antitrust Analysis of Suppression of Technology, 66 Antitrust L.J. 421, 429 n. 28 (1998)). While nominal suppression of technology can occur for a multitude of commercial and technological reasons, there is scant evidence that doing so coincides with harm to consumers, except where doing so affirmatively interferes with market competition under the antitrust laws—a claim not advanced here.

One reason the tort system is inapt for second-guessing commercial development and marketing decisions is that those decisions may be made for myriad reasons that do not map onto the specific safety concern of a products-liability action. For example, in the 1930s, AT&T abandoned the commercial development of magnetic recording “for ideological reasons. . . . Management feared that availability of recording devices would make customers less willing to use the telephone system and so undermine the concept of universal service.” (Mark Clark, Suppressing Innovation: Bell Laboratories and Magnetic Recording, 34 Tech. & Culture 516, 520-24 (1993)). One could easily imagine arguments that coupling telephones and recording devices would promote safety. But the determination of whether safety or universal service (and the avoidance of privacy invasion) was a “better” basis for deciding whether to pursue the innovation is not within the ambit of tort law (nor the capability of a products-liability jury). And yet, it would necessarily become so if the Court of Appeal’s decision were to stand.

A Proper Assessment of Public Policy Would Cut Strongly Against Adoption of the Court of Appeal’s Holding

The Court of Appeal notes that “a duty that placed manufacturers ‘under an endless obligation to pursue ever-better new products or improvements to existing products’ would be unworkable and unwarranted,” (Op. 10), yet avers that “plaintiffs are not asking us to recognize such a duty” because “their negligence claim is premised on Gilead’s possession of such an alternative in TAF; they complain of Gilead’s knowing and intentionally withholding such a treatment….” (Id).

From an economic standpoint, this is a distinction without a difference.

Both a “duty to invent” and a “duty to market” what is already invented would increase the cost of bringing any innovative product to market by saddling the developer with an expected additional (and unavoidable) obligation as a function of introducing the initial product, differing only perhaps by degree. Indeed, a “duty to invent” could conceivably be more socially desirable because in that case a firm could at least avoid liability by undertaking the process of discovering new products (a socially beneficial activity), whereas the “duty to market” espoused by the Court of Appeal would create only the opposite incentive—the incentive never to gain knowledge of a superior product on the basis of which liability might attach.[3]

And public policy is relevant. This Court in Brown v. Superior Court, (44 Cal. 3d 1049 (1988)), worried explicitly about the “[p]ublic policy” implications of excessive liability rules for the provision of lifesaving drugs. (Id. at 1063-65). As the Court in Brown explained, drug manufacturers “might be reluctant to undertake research programs to develop some pharmaceuticals that would prove beneficial or to distribute others that are available to be marketed, because of the fear of large adverse monetary judgments.” (Id. at 1063). The Court of Appeal agreed, noting that “the court’s decision [in Brown] was grounded in public policy concerns. Subjecting prescription drug manufacturers to strict liability for design defects, the court worried, might discourage drug development or inflate the cost of otherwise affordable drugs.” (Op. 29).

In rejecting the relevance of the argument here, however, the Court of Appeal (very briefly) argued a) that Brown espoused only a policy against burdening pharmaceutical companies with a duty stemming from unforeseeable harms, (Op. 49-50), and b) that the relevant cost here might be “some failed or wasted efforts,” but not a reduction in safety. (Op. 51).[4] Both of these claims are erroneous.

On the first, the legalistic distinction between foreseeable and unforeseeable harm was not, in fact, the determinative distinction in Brown. Rather, that distinction was relevant only because it maps onto the issue of incentives. In the face of unforeseeable, and thus unavoidable, harm, pharmaceutical companies would have severely diminished incentives to innovate. While foreseeable harms might also deter innovation by imposing some additional cost, these costs would be smaller, and avoidable or insurable, so that innovation could continue. To be sure, the Court wanted to ensure that the beneficial, risk-reduction effects of the tort system were not entirely removed from pharmaceutical companies. But that meant a policy decision that necessarily reduced the extent of tort-based risk optimization in favor of the manifest, countervailing benefit of relatively higher innovation incentives. That same calculus applies here, and it is this consideration, not the superficial question of foreseeability, that animated this Court in Brown.

On the second, the Court of Appeal inexplicably fails to acknowledge that the true cost of the imposition of excessive liability risk from a “duty to market” (or “duty to innovate”) is not limited to the expenditure of wasted resources, but the non-expenditure of any resources. The court’s contention appears to contemplate that such a duty would not remove a firm’s incentive to innovate entirely, although it might deter it slightly by increasing its expected cost. But economic incentives operate at the margin. Even if there remains some profit incentive to continue to innovate, the imposition of liability risk simply for the act of doing so would necessarily reduce the amount of innovation (in some cases, and especially for some smaller companies less able to bear the additional cost, to the point of deterring innovation entirely). But even this reduction in incentive is a harm. The fact that some innovation may still occur despite the imposition of considerable liability risk is not a defense of the imposition of that risk; rather, it is a reason to question its desirability, exactly as this Court did in Brown.

The Court of Appeal’s Decision Would Undermine Development of Lifesaving and Safer New Medicines

Innovation is a long-term, iterative process fraught with uncertainty. At the outset of research and development, it is impossible to know whether a potential new drug will ultimately prove superior to existing drugs. Most attempts at innovation fail to yield a marketable product, let alone one that is significantly safer or more effective than its predecessors. Deciding whether to pursue a particular line of research depends on weighing myriad factors, including the anticipated benefits of the new drug, the time and expense required to develop it, and its financial viability relative to existing products. Sometimes, potentially promising drug candidates are not pursued fully, even if theoretically “better” than existing drugs to some degree, because the expected benefits are not sufficient to justify the substantial costs and risks of development and commercialization.

If left to stand, the Court of Appeal’s decision would mean that whenever this stage of development is reached for a drug that may offer any safety improvement, the manufacturer will face potential liability for failing to bring that drug to market, regardless of the costs and risks involved in its development or the extent of the potential benefit. Such a rule would have severe unintended consequences that would stifle innovation.

First, by exposing manufacturers to liability on the basis of early-stage research that has not yet established a drug candidate’s safety and efficacy, the Court of Appeal’s rule would deter manufacturers from pursuing innovations in the first place. Drug research involves constant iteration, with most efforts failing and the potential benefits of success highly uncertain until late in the process. If any improvement, no matter how small or tentative, could trigger liability for failing to develop the new drug, manufacturers will be deterred from trying to innovate at all.

Second, such a rule would force manufacturers to direct scarce resources to developing and commercializing drugs that offer only small or incremental benefits because failing to do so would invite litigation. This would necessarily divert funds away from research into other potential drugs that could yield greater advancements. Further, as each small improvement is made, it reduces the relative potential benefit from, and therefore the incentive to undertake, further improvements. Rather than promoting innovation, the Court of Appeal’s decision would create incentives that favor small, incremental changes over larger, riskier leaps with the greatest potential to significantly advance patient welfare.

Third, and conversely, the Court of Appeal’s decision would set an unrealistic and dangerous standard of perfection for drug development. Pharmaceutical companies should not be expected to bring only the “safest” version of a drug to market, as this would drastically increase the time and cost of drug development and deprive patients of access to beneficial treatments in the meantime.

Fourth, the threat of liability would lead to inefficient and costly distortions in how businesses organize their research and development efforts. To minimize the risk of liability, manufacturers may avoid integrating ongoing research into existing product lines, instead keeping the processes separate unless and until a potential new technology is developed that offers benefits so substantial as to clearly warrant the costs and liability exposure of its development in the context of an existing drug line. Such an incentive would prevent potentially beneficial innovations from being pursued and would increase the costs of drug development.

Finally, the ruling would create perverse incentives that could actually discourage drug companies from developing and introducing safer alternative drugs. If bringing a safer drug to market later could be used as evidence that the first-generation drug was not safe enough, companies may choose not to invest in developing improved versions at all in order to avoid exposing themselves to liability. This would, of course, directly undermine the goal of increasing drug safety overall.

The Court of Appeal gave insufficient consideration to these severe policy consequences of the duty it recognized. A manufacturer’s decision when to bring a potentially safer drug to market involves complex trade-offs that courts are ill-equipped to second-guess—particularly in the limited context of a products-liability determination.

Conclusion

The Court of Appeal’s novel “duty to market” any known, less-harmful alternative to an existing product would deter innovation to the detriment of consumers. The Court of Appeal failed to consider how its decision would distort incentives in a way that harms the very patients the tort system is meant to protect. This Court should grant review to address these important legal and policy issues and to prevent this unprecedented expansion of tort liability from distorting manufacturers’ incentives to develop new and better products.

[1] No party or counsel for a party authored or paid for this amicus letter in whole or in part.

[2] It is important to note that this number varies with the kind of medicine involved, but across all categories of medicines there is a high likelihood of failure subsequent to Phase I trials.

[3] To the extent the concern is with disclosure of information regarding a potentially better product, that is properly a function of the patent system, which requires public disclosure of new ideas in exchange for the receipt of a patent. (See Brenner v. Manson, 383 U.S. 519, 533 (1966) (“one of the purposes of the patent system is to encourage dissemination of information concerning discoveries and inventions.”)). Of course, the patent system preserves innovation incentives despite the mandatory disclosure of information by conferring an exclusive right to the inventor to use the new knowledge. By contrast, using the tort system as an information-forcing device in this context would impose risks and costs on innovation without commensurate benefit, ensuring less, rather than more, innovation.

[4] The Court of Appeal makes a related argument when it claims that “the duty does not require manufacturers to perfect their drugs, but simply to act with reasonable care for the users of the existing drug when the manufacturer has developed an alternative that it knows is safer and at least equally efficacious. Manufacturers already engage in this type of innovation in the ordinary course of their business, and most plaintiffs would likely face a difficult road in establishing a breach of the duty of reasonable care.” (Op. at 52-3).