Spotlight

Introduction

On 11 October 2022, João Maia (Federal Deputy, Partido Liberal) proposed Bill 2768/22 (“Bill 2768” or “Bill”) on digital market regulation.[1] Bill 2768 is Brazil’s response to global trends toward the ex-ante regulation of digital platforms, and was at least partially inspired by the EU’s Digital Markets Act (“DMA”).[2] In our contribution to the public consultation on Bill 2768 (“Consultation”),[3] however, we argue that Brazil should be wary of importing untested regulation into its own, unique context. Rather than impulsively replicating the EU’s latest regulatory whim, Brazil should adopt a more methodical, evidence-based approach. Sound regulation requires that new rules be underpinned by a clear vision of the specific market failures they aim to address, as well as an understanding of the costs and potential unintended consequences. Unfortunately, Bill 2768 fails to meet these prerequisites. As we show in our response to the Consultation, it is far from clear that competition law in Brazil has failed to address issues in digital markets to the extent that would make sui generis digital regulation necessary. Indeed, it is unlikely that there are any truly “essential facilities” in the Brazilian digital market that would make access regulation necessary, or that “data” represents an unsurmountable barrier to entry. Other aspects of the Bill—such as the designation of Anatel as the relevant enforcer, the extremely low turnover thresholds used to ascertain gatekeeper status, and the lack of consideration given to consumer welfare as a relevant parameter in establishing harm or claiming an exemption—are also misguided. As it stands, therefore, Bill 2768 not only risks straining Brazil’s limited public resources, but also harming innovation, consumer prices, and the country’s thriving startup ecosystem.

Question 1

Identification of “essential facilities” in the universe of digital markets. Give examples of platform assets in the digital market operating in Brazil where at the same time: a) there are no digital platforms with substitute assets close to these assets b) these assets are difficult to duplicate efficiently at least close to the owning company c) without access to this asset, it would not be possible to operate in one or more markets, as it constitutes a fundamental input. Justify each of the examples given.

For the reasons we discuss below, it is unlikely that there are any examples of true “essential facilities” in digital markets in Brazil.

It important to define the meaning of “essential facility” precisely. The concept of essential facility is a state-of-the-art term used in competition law, which has been defined differently across jurisdictions. Still, the overarching idea of the essential facilities doctrines is that there are instances in which denial of access to a facility by an incumbent can distort competition. To demarcate between cases where denial of access constitutes a legitimate expression of competition on the merits from instances in which it indicates anticompetitive conduct, however, courts and competition authorities have devised a series of tests.

Thus, in the EU, the seminal Bronner case established that the essential facilities doctrine applies in Art. 102 TFEU cases when:

1. The refusal is likely to eliminate all competition in the market on the part of the person requesting the service;
2. The refusal is incapable of being objectively justified; and
3. The service in itself is indispensable to carrying out that person’s business, i.e., there is no actual or potential substitute for the requested input.[4]

In addition, the facility must be genuinely “essential” to compete, not merely convenient.

Similarly, CADE has incorporated the essential facilities doctrine into Brazilian competition policy by imposing a duty to deal with competitors.^[5]

The definition of “essential facilities” and, consequently, the breadth and limits of the essential facilities doctrine under Bill 2768/2022 (“Bill 2768”) should reflect tried and tested principles from competition law. There is no reason why essential facilities should be treated differently in “digital” markets, i.e., markets involving digital platforms, than in other markets. In this sense, we are concerned that the framing of Question 1 reveals an inconsistency that should be addressed before moving forward; namely, when a company’s assets are “difficult” to replicate efficiently, it is justified to force a competitor to grant access to those assets. This is misguided and could even produce the opposite of what Bill 2768 presumably aims to achieve.

As indicated above, the fundamental concept underpinning the essential facilities doctrine is that it applies to a product or service that is uneconomic or impossible to duplicate. Typically, this has applied to infrastructure, such as telecommunications or railways. For instance, expecting competitors to duplicate transport routes, such as railways, would be unrealistic — and economically wasteful. Instead, governments have often chosen to regulate these sectors as natural monopoly public utilities. Predominantly, this includes mandating access to all comers to such essential facilities under regulated prices and non-discriminatory conditions that make the activity of other companies viable and competitive—thus facilitating competition on a secondary market in situations in which competition might otherwise be impossible.

The government should ask itself to what extent this logic applies to so-called digital platforms, however.

Online search engines, for example, are not impossible or excessively difficult to replicate—nor is access to any one of them indispensable. Today, many search engines are on the market: Bing, Yandex, Ecosia, DuckDuckGo, Yahoo!, Google, Baidu, Ask.com, and Swisscows, among others.

More to the point, mere access to search engines isn’t really a problem. Rather, in most cases, those complaining about a search engine’s activity typically complain about access to the very first results, or they complain about the search engine prioritizing its own secondary-market services over those of the competitor. But this space is vanishingly scarce; there is no way for it to be allocated to all comers. Nor can it be allocated on neutral terms; by definition, a search engine must prioritize results.

Treating a search engine as an essential facility would generate problematic outcomes. For example, mandating non-discriminatory access to a search engine’s top results would be like requiring that a railroad offer service to all shippers at whatever time the shipper liked, regardless of railroad congestion, other shippers’ timetables, and the railroad’s optimization of its schedule. Not only would this be impossible, but it isn’t even required of traditional essential facilities.

Notably, while ranking high on a search engine results page is undoubtedly a boon for business, there are other ways of reaching customers. Indeed, as CADE ruled in a case concerning Google Shopping, even if the first page of Google’s result is relevant and important to ranked websites, it is not irreplaceable to the extent that there are other ways for consumers to find websites online. Google is not a mandatory intermediary for website access.^[6] Moreover, as noted, search results pages must, by definition, discriminate in order to function correctly. Deeming them essential facilities would entail endless wrangling (and technically complicated determinations) to decide if the search engine’s prioritization decisions were “proper” or not.

Similarly, online retail platforms like Amazon and Mercado Livre are very successful and convenient, but sellers can use other methods to reach customers. For example, they can sell from brick-and-mortar stores or easily set up their own retail websites using myriad software-as-a-service (“SaaS”) providers to facilitate processing and fulfilling orders. Furthermore, the concurrent presence and success of Mercado Livre, B2W (Submarino.com, Americanas.com, Shoptime, Soubarato), Cnova (Extra.com.br, Casasbahia.com.br, Pontofrio.com), Magazine Louiza, and Amazon on the Brazilian market belies the claim that any one of these platforms is indispensable or irreplicable.^[7]

Similar arguments can be made about the other digital platforms covered by Art. 6, paragraph II of Bill 2768. For example, WhatsApp may be by far the most popular interpersonal communication service in the country. Still, there are plenty of alternatives within easy (and mostly free) reach for Brazilian consumers, such as Messenger (62 million users), Telegram (30 million), Instagram (64 million), Viber (3 million), Hangouts (2 million), WeChat (1 million), Kik (500,000 users), and Line (1 million users). The sheer number of users of every app suggests that multi-homing is widespread.

In sum, while access to a particular digital platform may be convenient, especially if it is currently the most popular among users, it is highly questionable whether such access is essential. And, as Advocate General Jacobs noted in his opinion in Bronner, mere convenience does not create a right of access under the essential facilities doctrine.^[8]

Recommendation: Bill 2768 should make it clear that the principles and requirements of “essential facilities” within the meaning of competition law apply in full to the duties and obligations contemplated in Art. 10 — and that the finding of an “essential facility” is a prerequisite to the imposition of any such duties or obligations.

Question 2

Is regulation necessary to guarantee access to the asset(s) of the example(s) from Question 1? What should such regulation guarantee so that access to the asset enables third parties to enter those digital markets?

Before considering whether regulation is necessary to guarantee access to assets of certain companies, the government should first consider whether guaranteeing any such access is necessary and legitimate. In our response to Question 1, we have argued that it is unlikely to be. If the government nevertheless decides to the contrary, the next logical question should be whether competition law, including the essential facilities doctrine itself, are sufficient to address any such alleged problems as are identified in Question 2.

Arguably, the best way to answer this question would be through the natural experiment of letting CADE bring cases against digital platforms — assuming it can construct a prima facie case in each instance — and seeing whether or not traditional competition law tools provide a viable solution and, if not, whether these tools can be sharpened by reforming Brazil’s competition law or whether new, comprehensive ex-ante regulation is needed.

By comparison, the EU experimented with EU competition law before passing the DMA. In fact, most if not all the prohibitions and obligations of the DMA stem from competition law cases.^[9] The EU eventually decided that it preferred to pass blanket ex-ante rules against certain practices rather than having to litigate through competition law. Whether or not this was the right decision is up for debate, but one thing is certain: The EU tried its competition toolkit extensively against digital platforms before learning from the outcomes and deciding it needed to be complemented with a new set of broader, enforcer-friendly, bright-line rules.

By contrast, Brazil has initiated only a handful of antitrust cases against digital platforms. According to numbers published by CADE,^[10] CADE has reviewed 233 merger cases related to digital platform markets between 1995 and 2023 and, regarding unilateral conduct (monopolization cases)—those most relevant for the discussion on Bill 2768—opened 23 conduct cases. Regarding those 23 cases, 9 are still being investigated, 11 were dismissed, and only 3 were settled by the signature of a Cease-and-Desist Agreement (TCC). In this sense, only 3 cases (TCCs) out of 23 could be said to have been, to some extent, “condemned”. It is questionable whether these cases provide the sort of evidence of the existence of intrinsic competition problems in the eight service markets identified in Art. 6, paragraph II of Bill 2768 that would justify new, “sector-specific” access rules.^[11]

In fact, the recent entry of companies into many of those markets suggests that the opposite is closer to the truth. There are numerous examples of entry in a variety of digital services, including the likes of TikTok, Shein, Shopee, and Daki, to name just a few.

Serious problems can arise when products that are not essential facilities are treated as such, of which we name two.

First, over-extending the essential facilities doctrine can encourage free riding.^[12] This is not what the essential facilities doctrine, properly understood, aims to achieve, nor what it should be used for:

Consequently, the [European Court of Justice] implies that the [essential facilities doctrine] is not designed for the convenience of undertakings to free ride dominant undertakings, but only for the necessity of survival on the secondary market in situations where there are no effective substitutes.^[13]

Why develop a competing online retail platform when access to Mercado Livre or Amazon is guaranteed by law? Free riding can discourage investments from third companies and targeted “gatekeepers,” especially in the development and improvement of competing business platforms (or alternative business models that are not exact replicas of existing platforms). Contrary to the stated goals of Bill 2768, this could further entrench incumbents, as the ability to free ride on others’ investments incentivizes companies to pivot away from contesting incumbents’ core markets to acting as complementors in those markets.

Indeed, a serious—and underappreciated—concern is the cost of excessive risk-taking by companies that can rely on regulatory protections to ensure continued viability even when it is not warranted.

Businesses must develop their business models and operate their businesses in recognition of the risk involved. A complementor that makes itself dependent upon a platform for distribution of its content does take a risk. Although it may benefit from greater access to users, it places itself at the mercy of the other — or at least faces great difficulty (and great cost) adapting to unanticipated platform changes over which it has no control. This is a species of the “asset specificity” problem that animates much of the Transaction Cost Economics literature.^[14]

But the risk may be a calculated one. Firms occupy specialized positions in supply chains throughout the economy, and they make risky, asset-specific investments all the time. In most circumstances, firms use contracts to allocate both risk and responsibility in a way that makes the relationship viable. When it is too difficult to manage risk by contract, firms may vertically integrate (thus aligning their incentives) or simply go their separate ways.

The fact that a platform creates an opportunity for complementors to rely upon it does not mean that a firm’s decision to do so — and to do so without a viable contingency plan — makes good business sense. In the case of the comparison-shopping sites at issue in the EU’s Google Shopping decision,^[15] for example, it was entirely predictable that Google’s algorithm would evolve. It was also entirely predictable that it would evolve in ways that could diminish or even eviscerate their traffic. As one online marketing expert put it, “counting on search engine traffic as your primary traffic source is a bit foolish, to say the least.”^[16]

Providing guarantees (which is what a “gatekeeper” access rule accomplishes) in this situation creates a significant problem: Protecting complementors from the inherent risk in a business model in which they are entirely dependent upon another company with which they have no contractual relationship is at least as likely to encourage excessive risk taking and inefficient over-investment as it is to ensure that investment and innovation are not too low.^[17]

Second, granting companies and competitors access to goods or services except in the very few and narrow cases^[18] in which access to such goods and services is truly essential to sustain competition on the market sends platforms the wrong message. The message is that, after being encouraged to compete, successful companies will be punished for thriving. This is contrary to the spirit of competition law and the principle of free competition, which Bill 2768 should be careful not to eviscerate. As the great U.S. jurist Learned Hand observed in U.S. v. Aluminum Co. of America: “The successful competitor, having been urged to compete, must not be turned upon when he wins.”^[19]

Furthermore, forcing companies to do business with third parties is at odds with the principle that, unless a violation of antitrust law can be ascertained, companies should be free to do business with whomever they choose.^[20] Indeed, it is a cornerstone of the free market economy that “the antitrust laws [do] not impose a duty on [firms] . . . to assist [competitors] . . . to ‘survive or expand.’”^[21]

Question 3

Describe cases in digital markets where there is at least one other company with substitute assets close to these assets of the main company, but none of the digital platforms that hold the asset provide access to it. In other words, even if there is more than one asset in the market, there is still a problem of accessing the asset. How could Bill 2768/2022, especially its article 10, be improved to improve access to essential supplies?

We are aware of no such cases.

Question 4

Describe cases in which the ownership of data in digital markets creates a barrier to entry that makes it very difficult or even impossible for incumbent digital platforms to enter the market. How could Bill 2768/2022 mitigate this problem, reducing the barrier to entry represented by access to data?

The extent to which data represents a barrier to entry is, in our opinion, vastly overstated. Bill 2768 should not assume that data is a barrier to entry and should assess claims to the contrary critically — especially if it intends to build a new, comprehensive regulatory regime on that assumption.^[22]

In a nutshell, theories of “data as a barrier to entry” make the assertion that online data can amount to a barrier to entry, insulating incumbent services from competition and ensuring that only the largest providers thrive. This data barrier to entry, it is alleged, can then allow firms with monopoly power to harm consumers, either directly through “bad acts” like price discrimination, or indirectly by raising the costs of advertising, which then get passed on to consumers.^[23]

However, the notion of data as an antitrust-relevant barrier to entry is more supposition than reality.

First, despite the rush to embrace “digital platform exceptionalism,” data is useful to all industries. “Data” is not some new phenomenon particular to online companies. It bears repeating that offline retailers also receive substantial benefit from, and greatly benefit consumers by, knowing more about what consumers want and when they want it. Through devices like coupons, membership discounts and loyalty cards (to say nothing of targeted mailing lists and the age-old practice of data mining check-out receipts), brick-and-mortar retailers can track purchase data and better serve consumers. Not only do consumers receive better deals for using them, but retailers know what products to stock and advertise and when and on what products to run sales.^[24]

Of course, there are a host of other uses for data, as well, including security, fraud prevention, product optimization, risk reduction to the insured, knowing what content is most interesting to readers, etc. The importance of data stretches far beyond the online world, and far beyond mere retail uses more generally. To describe any one company as having a monopoly on data is therefore mistaken.

Second, it is not the amount of data that leads to success, but how that data is used to craft attractive products or services for users. In other words: information is important to companies because of the value that can be drawn from it, not for the inherent value of the data itself. Thus, many companies that accumulated vast amounts of data were subsequently unable to turn that data into a competitive advantage to succeed on the market. For instance, Orkut, AOL, Friendster, Myspace, Yahoo! and Flicker — to name a few — all gained immense popularity and access to significant amounts of data, but failed to retain their users because their products were ultimately lackluster.

Data is not only less important than what can be drawn from it, but data is also less important than the underlying product it informs. For instance, Snapchat created a challenger to Facebook so successfully (and in such a short time) that Facebook attempted to buy it for $3 billion (Google offered $4 billion). But Facebook’s interest in Snapchat was not about its data. Instead, Snapchat was valuable — and a competitive challenge to Facebook — because it cleverly incorporated the (apparently novel) insight that many people wanted to share information in a more private way.

Relatedly, Twitter, Instagram, LinkedIn, Yelp, TikTok (and Facebook itself) all started with little (or no) data but nevertheless found success. Meanwhile, despite its supposed data advantages, Google’s attempt at social networking, Google+, never caught up to Facebook in terms of popularity to users (and thus not to advertisers either) and shut down in 2019.

At the same, it is not the case that the alleged data giants — the ones supposedly insulating themselves behind data barriers to entry — actually have the type of data most relevant to startups anyway. As Andres Lerner has argued, if you wanted to start a travel business, the data from Kayak or Priceline (or local Decolar.com) would be far more relevant.^[25] Or if you wanted to start a ride-sharing business, data from cab companies would be more useful than the broad, market-cross-cutting profiles Google and Facebook have. Consider companies like Uber and 99 that had no customer data when they began to challenge established cab companies that did possess such data. If data were really so significant, they could never have competed successfully. But Uber and 99 have been able to effectively compete because they built products that users wanted to use — they came up with an idea for a better mousetrap. The data they have accrued came after they innovated, entered the market, and mounted their successful challenges — not before.

Complaints about data facilitating unassailable competitive advantages thus have it exactly backwards. Companies need to innovate to attract consumer data, otherwise consumers will switch to competitors (including both new entrants and established incumbents). As a result, the desire to make use of more and better data drives competitive innovation, with manifestly impressive results: The continued explosion of new products, services and other apps is evidence that data is not a bottleneck to competition but a spur to drive it.

Third, competition online is (metaphorically—but not by much) one click or thumb swipe away. That is, barriers to entry and switching costs are low. Indeed, despite the alleged prevalence of data barriers to entry, competition online continues to soar, with newcomers constantly emerging and triumphing. The entry of online retailers and other digital platforms in Brazil is a case in point (See Questions 1 and 2). This suggests that the barriers to entry are not so high as to prevent robust competition.

Again, despite the supposed data-based monopolies of Facebook, Google, Amazon, Apple, and others, there exist powerful competitors in the markets they compete in:

• If consumers want to make a purchase, they are more likely to do their research on Mercado Livre or Amazon than Google or Facebook, even with Facebook’s launch of Facebook Marketplace.
• Google flight search has failed to seriously challenge — let alone displace — its competitors, as critics feared. Decolar.com, Kayak, Expedia, and the like remain the most prominent travel search sites — despite Google having literally purchased ITA’s trove of flight data and data-processing acumen.
• ChatGPT, one of the most highly valued startups today, is now a serious challenger to traditional search engines.
• TikTok has rapidly risen to challenge popular social media apps like Instagram and Facebook.

Even assuming for the sake of argument that data creates a barrier to entry, there is little evidence that consumers cannot easily switch to a competitor. While there are sometimes network effects online, like with social networking, history still shows that people will switch. Myspace was considered a dominant network until it made a series of bad business decisions, and users ended up on Facebook instead; Orkut had a similar fate. Similarly, Internet users can and do use Bing, DuckDuckGo, Yahoo!, and a plethora of more specialized search engines on top of and instead of Google, and increasingly also turn to other ways to find information online (such as searching for a brand or restaurant directly on Instagram or TikTok, or asking ChatGPT a question). In fact, Google itself was once an upstart new entrant that replaced once-household names like Yahoo! and AltaVista.

Fourth, access to data is not exclusive. Data is not like oil. If, for example, Petrobras drills and extracts oil from the ground, that oil is no longer available to other companies. Data is not finite in the same way. Google knowing someone’s birthday doesn’t limit the ability of Facebook to know the same person’s birthday, as well. While databases may be proprietary, the underlying data is not. And what matters more than the data itself is how well it is analyzed (see first point). Because data is not exclusive like oil, any attempt to force the sharing of data in an attempt to help competitors creates a free-riding problem. Why go through the work of collecting valuable data on customers to learn what they want so you can better serve them when regulation mandates that Apple effectively give you the data?

In conclusion, the problem with granting competitors access to data is that data is a consequence of competition, not a prerequisite for it. Thus, rather than enhancing their ability to compete, “gifting” competitors the fruits of others’ successful attempts at competition risks destroying both groups’ incentives to design attractive products to accrue such data in the first place. By reversing the competition-data causality, Bill 2768 ultimately risks inadvertently stifling the same competition that it purportedly seeks to bolster.

Question 5

Cite cases in which a company in the digital market in Brazil used third-party data because of its characteristic as an essential input provider, harming the third party competitively?

We are not aware of any such cases.

However, the framing of this question should be clear about what is meant by “harming a third party competitively.” The use of third-party data is a key driver of competition. Even if competitors are “harmed” as a result, they are harmed only insofar as they do not match the price or quality offered by the platform.

Competition is, to a large extent, driven by the use of knowledge of rivals’ products — including their price, quality, quantity, and how they are sold and presented to consumers. In fact, the model of perfect competition largely assumes that all the products on the market are homogeneous (even if this is rarely borne out in practice). The use of third-party data to match and beat competitor’s offerings can be seen as a modern expression of this dynamic. Indeed, as we have written before:

We cannot assume that something is bad for competition just because it is bad for certain competitors. A lot of unambiguously procompetitive behavior, like cutting prices, also tends to make life difficult for competitors. The same is true when a digital platform provides a service that is better than alternatives provided by the site’s third-party sellers. […].

There’s no doubt this is unpleasant for merchants that have to compete with these offerings. But it is also no different from having to compete with more efficient rivals who have lower costs or better insight into consumer demand. Copying products and seeking ways to offer them with better features or at a lower price, which critics of self-preferencing highlight as a particular concern, has always been a fundamental part of market competition—indeed, it is the primary way competition occurs in most markets.^[26]

Any per se prohibition of the use of third-party data would preclude digital platforms from using data to improve their product offering in ways that could benefit consumers.

Recommendation: Assuming that competition law and IP law are not up to the task of curbing abuses of third-party data, Bill 2768 should ensure that such prohibitions are tailor-made to cover conduct that has no other rational explanation other than seeking to exclude a competitor. It should not capture uses of third-party data that drives competition and benefit consumers, even if this results in the exit of a competitor from the market.

Question 6

Describe cases in which a difficulty in interoperability with a company’s systems makes it very difficult or impossible to enter one or more digital markets. How could Bill 2768/2022 mitigate this problem, reducing the barrier to entry represented by lack of interoperability?

We are not aware of any such cases.

However, when considering potential interoperability mandates, the government should be aware of the risks and trade-offs that come with such measures, especially in terms of safety, security, and privacy (see Question 8 for a more detailed discussion).

Question 7

The European Digital Market Act (DMA) chose to implement absolute prohibitions (per se) on some conduct in digital markets, such as self-preferencing, among others. Bill 2768/2022, on the other hand, chose not to do any prohibited conduct ex ante. Should there be one or more conducts with absolute prohibitions (per se) in Bill 2768/2022? Why? Please propose wording, explaining where in the bill it would be located?

No, there should not be absolute prohibitions on these sorts of conduct, especially without substantive experience suggesting that such conduct is always or almost always harmful and largely irredeemable (in this item, we answer the question in general terms; please see Question 8 for a discussion of why particular conduct (e.g., self-preferencing) should not be prohibited).

Regardless of the harm to the business of the targeted companies, overly broad prohibitions (or mandates) can harm consumers by chilling procompetitive conduct and discouraging innovation and investment, especially when no showing of harm is required and the law is not amenable to efficiencies arguments (like in the case of the DMA). The fact that such prohibitions apply to vastly different markets (for example, cloud services have little to do with search engines) regardless of context is also a sure sign that they are overly broad and poorly designed.

In fact, there are indications that where the DMA has been introduced, it has delayed the advance of technology. For example, Google’s “Bard” AI was rolled out later in Europe due to the EU’s uncertain and strict AI And privacy regulations.^[27] Similarly, Meta’s “Threads” is not available in the EU precisely due to the constraints imposed by the DMA and the EU’s data privacy regulation (GDPR).^[28] Elon Musk, X’s (formerly Twitter) CEO, has indicated that the cost of complying with EU digital regulations, such as the DSA, could prompt it to exit the European market.^[29] Recently, Microsoft delayed the European rollout of its new AI, “Copilot,” because of the DMA.[30]

Apart from capturing pro-competitive conduct that benefits consumers and freezing technology in time (which would ultimately exacerbate the technological chasm between more and less advanced countries), rigid per se rules could also capture many budding companies that cannot be considered “gatekeepers” by any stretch of the imagination. This risk is especially real in the case of Brazil given the extremely low threshold for what constitutes a “gatekeeper” enshrined in Article 9 (R$70 million, or approximately USD$14 million). Thus, many Brazilian unicorns could, either immediately or in the near future, be captured by the new, restrictive rules, which could stunt their growth and chill innovative products. Ultimately, this could imperil Brazil’s current status as “[Latin America’s] most established startup hub” and cast a shadow on what The Economist has referred to as the bright future of Latin American startups.^[31]

The list of harmed companies could include some of Brazil’s most promising unicorns, such as:

• 99 (transport app)
• Neon Bank (digital bank)
• C6 Bank (digital bank)
• CloudWalk (payment method)
• Creditas (lending platform)
• Ebanx (payment solutions)
• Facily (social commerce)
• com (road freight)
• Gympass (gym aggregator and corporate benefits)
• Hotmart (platform for selling digital products)
• iFood (delivery)
• Loft (real estate platform)
• Loggi (logistics)
• Mercado Bitcoin (cryptocurrency broker)
• Merama (e-commerce)
• Madeira Madeira (home and decoration products store)
• Nubank (bank)
• Olist (e-commerce)
• Wildlife Studios (game developer)
• Quinto Andar (rental platform)
• Vtex (technology and digital commerce)
• Unico (biometrics)
• Dock (infrastructure)
• Pismo (technology for payments and banking services)^[32]

Question 8

Would there be behaviors in digital markets that would have a high potential to entail competitive problems, but which can be justified as generating greater efficiency for companies, transactions, and markets? Give examples of these behaviors? How should these behaviors be treated in Bill 2768/2022? In particular, a “reversal of the burden of proof” would be appropriate, in which such conduct would presumably be anti-competitive, but would it be appropriate to authorize a defense of digital platforms based on these efficiencies? Should these behaviors be considered not prohibited per se, but as a “reversal of the burden of proof” in Bill 2768/2022?

There are certain types of behavior in digital markets that have been targeted by ex-ante regulations but which are nevertheless capable of, or even central to, delivering significant procompetitive benefits. It would be unjustified and harmful to subject such conduct to per se prohibitions or to reverse the burden of proof. Instead, this type of conduct should be approached neutrally, and examined on a case-by-case basis.^[33]

A.       Self-Preferencing

Self-preferencing occurs when a company gives preferential treatment to one of its own products (presumably, this type of behavior could be caught by Art. 10, paragraph II of Bill 2768). An example would be Google displaying its shopping service at the top of search results ahead of alternative shopping services. Critics of this practice argue that it puts dominant firms in competition with other firms that depend on their services, and this allows companies to leverage their power in one market to gain a foothold in an adjacent market, thus expanding and consolidating their dominance. However, this behavior can also be procompetitive and beneficial to users.

Over the past several years, a growing number of critics have argued that big tech platforms harm competition by favoring their own content over that of their complementors. Over time, this argument against self-preferencing has become one of the most prominent among those seeking to impose novel regulatory restrictions on these platforms.

According to this line of argument, complementors would be “at the mercy” of tech platforms. By discriminating in favor of their own content and against independent “edge providers,” tech platforms cause “the rewards for edge innovation [to be] dampened by runaway appropriation,” leading to “dismal” prospects “for independents in the internet economy—and edge innovation generally.”^[34]

The problem, however, is that the claims of presumptive harm from self-preferencing (also known as “vertical discrimination”) are based neither on sound economics nor evidence.

The notion that platform entry into competition with edge providers is harmful to innovation is entirely speculative. Moreover, it is flatly contrary to a range of studies showing that the opposite is likely true. In reality, platform competition is more complicated than simple theories of vertical discrimination would have it,^[35] and the literature establishes that there is certainly no basis for a presumption of harm.^[36]

The notion that platforms should be forced to allow complementors to compete on their own terms, free of constraints or competition from platforms is a species of the idea that platforms are most socially valuable when they are most “open.” But mandating openness is not without costs, most importantly in terms of the effective operation of the platform and its own incentives for innovation.

“Open” and “closed” platforms are different ways of supplying similar services, and there is scope for competition between these alternative approaches. By prohibiting self-preferencing, a regulator might therefore close down competition to the detriment of consumers. As we have noted elsewhere:

For Apple (and its users), the touchstone of a good platform is not ‘openness,’ but carefully curated selection and security, understood broadly as encompassing the removal of objectionable content, protection of privacy, and protection from ‘social engineering’ and the like. By contrast, Android’s bet is on the open platform model, which sacrifices some degree of security for the greater variety and customization associated with more open distribution. These are legitimate differences in product design and business philosophy.^[37]

Moreover, it is important to note that the appropriation of edge innovation and its incorporation into the platform (a commonly decried form of platform self-preferencing) greatly enhances the innovation’s value by sharing it more broadly, ensuring its coherence with the platform, incentivizing optimal marketing and promotion, and the like. Smartphones are now a collection of many features that used to be offered separately, such as phones, calculators, cameras and gaming consoles, and it is clear that the incorporation of these features in a single device has brought immense benefits to consumers and society as a whole. In other words, even if there is a cost in terms of reduced edge innovation, the immediate consumer welfare gains from platform appropriation may well outweigh those (speculative) losses.

Crucially, platforms have an incentive to optimize openness (and to assure complementors of sufficient returns on their platform-specific investments). This does not mean that maximum openness is optimal, however; in fact, typically a well-managed platform will exert top-down control where doing so is most important, and openness where control is least meaningful.^[38]

But this means that it is impossible to know whether any particular platform constraint (including self-prioritization) on edge provider conduct is deleterious, and similarly whether any move from more to less openness (or the reverse) is harmful.

This is the situation that leads to the indeterminate and complex structure of platform enterprises. Consider the big online platforms like Google and Facebook, for example. These entities elicit participation from users and complementors by making access to their platforms freely available for a wide range of uses, exerting control over access only in limited ways to ensure high quality and performance. At the same time, however, these platform operators also offer proprietary services in competition with complementors or offer portions of the platform for sale or use only under more restrictive terms that facilitate a financial return to the platform.

The key is understanding that, while constraints on complementors’ access and use may look restrictive compared to an imaginary world without any restrictions, in such a world the platform would not be built in the first place. Moreover, compared to the other extreme — full appropriation (under which circumstances the platform also would not be built…) — such constraints are relatively minor and represent far less than full appropriation of value or restriction on access. As Jonathan Barnett aptly sums it up:

The [platform] therefore faces a basic trade-off. On the one hand, it must forfeit control over a portion of the platform in order to elicit user adoption. On the other hand, it must exert control over some other portion of the platform, or some set of complementary goods or services, in order to accrue revenues to cover development and maintenance costs (and, in the case of a for-profit entity, in order to capture any remaining profits).^[39]

For instance, companies may choose to favor their own products or services because they are better able to guarantee their quality or quick delivery.^[40] Mercado Livre, for instance, may be better placed to ensure that products provided by the ‘Mercado Envios logistics service are delivered in a timely manner compared to other services. Consumers may benefit from self-preferencing in other ways, too. If, for instance, Google were prevented from prioritizing Google Maps or YouTube videos in its search queries, it could be harder for users to find optimal and relevant results. If Amazon is prohibited from preferencing its own line of products on the marketplace, it may instead opt not to sell competitors’ products at all.

The power to prohibit the requiring or incentivizing of customers of one product to use another would enable the limiting or prevention of self-preferencing and other similar behavior. Granted, traditional competition law has sought to restrict the ‘bundling’ of products by requiring them to be purchased together, but to prohibit incentivization as well goes much further.

B.        Interoperability

Another mot du jour is interoperability, which might fall under Art. 10, paragraph IV of Bill 2768. In the context of digital ex ante regulation, ‘interoperability’ means that covered companies could be forced to ensure that their products integrate with those of other firms. For example, requiring a social network to be open to integration with other services and apps, a mobile operating system to be open to third-party app stores, or a messaging service to be compatible with other messaging services. Without regulation, firms may or may not choose to make their software interoperable. However, Europe’s DMA and the UK’s prospective Digital Markets, Competition and Consumer Bill (“DMCC”),^[41] will allow authorities to require it. Another example is data ‘portability,’ which allows customers to move their data from one supplier to another, in the same way that a telephone number can be kept when one changes network.

The usual argument is that the power to require interoperability might be necessary to ‘overcome network effects and barriers to entry/expansion.’ However, the Brazilian government should not overlook that this solution comes with costs to consumer choice, in particular by raising difficulties with security and privacy, as well as having questionable benefits for competition. In fact, it is not as though competition disappears when customers cannot switch as easily as they turn on a light. Companies compete upfront to attract such consumers through tactics like penetration pricing, introductory offers, and price wars.^[42]

A closed system, that is, one with comparatively limited interoperability, can help limit security and privacy risks. This can encourage use of the platform and enhance the user experience. For example, by remaining relatively closed and curated, Apple’s App Store gives users the assurance that apps will meet a certain standard of security and trustworthiness. Thus, ‘open’ and ‘closed’ ecosystems are not synonymous with ‘good’ and ‘bad,’ and instead represent two different product design philosophies, either of which might be preferred by consumers. By forcing companies to operate ‘open’ platforms, interoperability obligations could thus undermine this kind of inter-brand competition and override consumer choices.

Apart from potentially damaging user experience, it is also doubtful whether some of the interoperability mandates, such as those between social media or messaging services, can achieve their stated objective of lowering barriers to entry and promoting greater competition. Consumers are not necessarily more likely to switch platforms simply because they are interoperable. In fact, there is an argument to be made that making messaging apps interoperable in fact reduces the incentive to download competing apps, as users can already interact with competitors’ apps from the incumbent messaging app.

C.       Choice Screens

Some ex-ante rules seek to address firms’ ability to influence user choice of apps through pre-installation, defaults, and the design of app stores (this could fall under Art. 10, paragraph II of Bill 2768). This has sometimes resulted in the imposition of requirements to provide users with ‘choice screens,’ for instance requiring users to choose which search engine or mapping service is installed on their phone. In this sense, it is important to understand the trade-offs at play here: choice screens may facilitate competition, but they may do so at the expense of the user experience, in terms of the time taken to make such choices. There is a risk, without evidence of consumer demand for ‘choice screens,’ that such rules impose the legislator’s preference for greater optionality over what is most convenient for users. Unless there is explicit public demand in Brazil for such measures, it would be ill-advised to implement a choice screen obligation.

D.       Size and Market Power

In general, many of the prohibitions and obligations contemplated in ex-ante rules target incumbents’ size, scalability, and “strategic significance.”

It is widely claimed that because of network effects, digital markets are prone to ‘tipping’ whereby when one producer gains a sufficient share of the market, it quickly becomes a complete or near-complete monopolist. Although they may begin as very competitive, these markets therefore exhibit a marked ‘winner takes all’ characteristic. Ex ante rules often try to avert or revert this outcome by targeting a company’s size, or by targeting companies with market power.

However, there are many investments and innovations that will – if permitted – benefit consumers, either immediately or in the longer term, but which may have some effect on enhancing market power, a companies’ size, or its strategic significance. Indeed, improving a firm’s products and thereby increasing its sales will often lead to increased market power.

Accordingly, targeting “size” or conduct which bolsters market power, without any accompanying evidence of harm, creates a serious danger of a very broad inhibition of research, innovation, and investment – all to the detriment of consumers. Insofar as such rules prevent the growth and development of incumbent firms, they may also harm competition, since it may well be these firms that – if permitted – are most likely to challenge the market power of other firms in other, adjacent markets. The cases of Disney, Apple, Amazon and Globo’s launch of video-on-demand services to compete with Netflix, and Meta’s introduction of ‘Threads’ as a challenge to Twitter (or ‘X’), appear to be an example. Here, per se rules that have the aim of prohibiting the bolstering of size or market power in one area may in fact prevent entry by one firm into a market dominated by another. In that case, policymaker action protects monopoly power. Therefore, a much subtler approach to regulation is required.

Bill 2768’s reference to Tim Wu’s The Curse of Bigness, which notoriously adopts a reductive “big is bad” ethos, suggests that it could be making a similarly flawed assumption.^[43]

E.        Conclusion

We do not think it is appropriate to reverse the burden of proof in any instances in the context of digital platforms. Without substantive evidence that such conduct causes widespread harm to a well-defined public interest (e.g., similar to cartels in the context of antitrust law), there is no justification for a reversal of the burden of proof, and any such reversal of the burden of proof risks undermining consumer benefits, innovation, and discouraging investment in the Brazilian economy for a justified fear that procompetitive conduct will result in fines and remedies. By the same token, we do think that where the appointed enforcer makes a prima facie case of harm, whether in the context of antitrust law or ex-ante digital regulation, it should also be prepared to address arguments related to efficiencies.

Question 9

Is there a need for a regulator? If so, which regulator would be better able to implement the regulation provided for in Bill 2768/2022? Anatel, CADE, ANPD, another existing or new regulator? Justify.

Despite the lack of clarity concerning the law’s goals and objectives, the rules proposed by Bill 2768 appear to be competition based, at least insofar as they seek to bolster free competition, consumer protection, and tackle “abuse of economic power” (Art. 4). Therefore, the agency best positioned to enforce it would, in principle, be CADE (the goals of Act 12.529/11, the Brazilian Competition Law, overlap significantly with those under Bill 2768). Conversely, there is a palpable risk that, in discharging its duties under Bill 2768, Anatel would transpose the logic and principles of telecommunications regulation to “digital” markets, which is misguided as these are two very different things.

Not only are “digital” markets substantively different from telecommunications markets, but there is really no such thing as a clearly demarcated concept of “digital market.” For example, the digital platforms described in Art. 6, paragraph II of Bill 2768 are not homogenous, and cover a range of different business models. In addition, virtually every market today incorporates “digital” elements, such as data. Indeed, companies operating in sectors as divergent as retail, insurance, healthcare, pharma, production, and distribution have all been “digitalized.” Thus, an enforcer with a nuanced understanding of the dynamics of digitalization and, especially, the idiosyncrasies of digital platforms as two-sided markets, appears necessary. While CADE arguably lacks substantive experience with digital platforms, it is better placed to enforce Bill 2768 than Anatel because of its deep experience with the enforcement of competition policy.

Question 10

Do you think that there could be any risk of bis in idem between the regulator and the competition authority with the same conduct being analyzed by both?

Based on the EU experience, there is a risk of double jeopardy at the intersection of traditional competition law and ex-ante digital regulation.

By way of comparison, and as Giuseppe Colangelo has written, the DMA is grounded explicitly on the notion that competition law alone is insufficient to effectively address the challenges and systemic problems posed by the digital platform economy.^[44] Indeed, the scope of antitrust is limited to certain instances of market power (e.g., dominance on specific markets) and of anti-competitive behavior. Further, its enforcement occurs ex post and requires extensive investigation on a case-by-case basis of what are often very complex sets of facts and may not effectively address the challenges to well-functioning markets posed by the conduct of gatekeepers, who are not necessarily dominant in competition-law terms — or so its proponents argue. As a result, regimes like the DMA invoke regulatory intervention to complement traditional antitrust rules by introducing a set of ex ante obligations for online platforms designated as gatekeepers. This also allows enforcers to dispense with the laborious process of defining relevant markets, proving dominance, and measuring market effects.

However, despite claims that the DMA is not an instrument of competition law, and thus would not affect how antitrust rules apply in digital markets, the regime does appear to blur the line between regulation and antitrust by mixing their respective features and goals. Indeed, the DMA shares the same aims and protects the same legal interests as competition law.

Further, its list of prohibitions is effectively a synopsis of past and ongoing antitrust cases, such as Google Shopping (Case T-612/17), Apple (AT.40437) and Amazon (Cases AT.40462 and AT.40703).^[45] Acknowledging the continuum between competition law and the DMA, the European Competition Network (ECN) and some EU member states (self-anointed “friends of an effective DMA”) initially proposed empowering national competition authorities (NCAs) to enforce DMA obligations.^[46]

Similarly, the prohibitions and obligations contemplated in Art. 10 of Bill 2768 could, in theory, all be imposed by CADE. In fact, CADE has investigated, and is still investigating, several large companies which would (likely) fall within the purview of Bill 2768, such as Google, Apple, Meta, (still under investigation) Booking.com, Decolar.com, Expedia and iFood (settled through case-and-desist agreements), and Uber (all investigations closed without penalties; following an economic study, CADE found that Uber’s entry benefitted consumers[47]). CADE’s past and current investigations against these companies already covered conducts that are targeted by the DMA and Bill 2768, such as refusal to deal, self-preferencing, and discrimination.^[48] Existing competition law under Act 12.529/11, the Brazilian Competition Law, thus clearly already captures the sort of conduct which is included under Bill 2768. In addition, the requirement to use data “adequately” is likely covered by data protection regulation in Brazil (Lei Geral de Proteção de Dados, LGPD, Lei Federal Nº 13.709/2018).

The difference between the two regimes is that, while general antitrust law requires a showing of harm (even if potential) and exempts conduct with net benefits to consumers, Bill 2768 in principle does not. The only limiting principle to the prohibitions and obligations contained in Art. 10 Art. 11 (III) is the principle of proportionality — which is a general principle of constitutional law and should, in any case, apply regardless of Bill 2768. Thus, the only limiting principle of Art. 10, framed broadly, is redundant.

There is one additional complication. Bill 2768 pursues many (though not all) of the same objectives as Act 12.529/11. Insofar as these objectives are shared, it could lead to double jeopardy i.e., the same conduct being punished twice under slightly different regimes. But it could also produce contradictory results because, as pointed out above, the objectives pursued by the two bills are not identical. Act 12.529/11 is guided by the goals of “free competition, freedom of initiative, social role of property, consumer protection and prevention of the abuse of economic power” (Art. 1). To these objectives, Bill 2768 adds “reduction of regional and social inequalities,” and “increase of social participation in matters of public interest.” While it is true that these principles derive from Art. 170 of the Brazilian Constitution (“economic order”), the mismatch between the goals of Act 12.529/11 and Bill 2768 and their enforcing authorities is sufficient as to lead to situations in which conduct that is allowed or even encouraged under Act 12.529/11 is prohibited under Bill 2768. For instance, procompetitive conduct by a covered platform could nevertheless exacerbate “regional or social inequalities” because it invests heavily in one region, but not others. In a similar vein, safety, privacy, and security measures implemented by, say, an operator of an App Store, which would typically be considered beneficial for consumers under antitrust law,^[49] could feasibly lead to less participation in discussions of public interest (assuming one could easily define the meaning of such a term).

Accordingly, Bill 2768 could fragment Brazil´s legal framework due to overlaps with competition law, stifle procompetitive conduct, and lead to contradictory results. This, in turn, is likely to impact legal certainty and the rule of law in Brazil, which could adversely affect Foreign Direct Investment.^[50] Furthermore, coordination between CADE and Anatel is likely to be costly, if the latter ends up being the designated enforcer of Bill 2768. Brazil would essentially have two Acts pursuing the same or similar goals being implemented by two different agencies, with all the extra compliance and coordination costs that come with such duplicity.

Question 11

What is your assessment of the criteria of art. 9 of Bill 2768/2022? Should it be changed? By what criteria? Is it necessary to designate the essential service-to-service access control power holder?

This criterion seems arbitrary and, in any case, extremely low. There is no objective reason that would link “power to control access” with turnover. Furthermore, even if one admits, for the sake of argument, that turnover is a relevant indication of gatekeeper power, a R$70 million threshold would capture dozens, if not hundreds of companies active in a range of industries. This can lead to a situation in which a law that was initially — and purportedly — aimed at very specific “digital” firms, like Google, Amazon, Apple, Microsoft, etc., ends up, by and large, covering a host of other, comparatively small firms, including some of Brazil’s most valuable unicorns (see Question 7). On the other hand, it is also questionable from a rule of law perspective whether a law should seek to identify the specific companies it will apply to in advance.

Lessons can be drawn from the UK’s DMCC, which has made a similar mistake. Pursuant to the current proposal for a DMCC, the UK’s CMA will be able to designate a company as having “significant market status” (“SMS”) where it takes part in a ‘digital activity linked to the United Kingdom’, and, in relation to this digital activity, has ‘substantial and entrenched market power’ and is in ‘a position of strategic significance’ (s. 2), and has a turnover of at least £1 billion in the UK or £25 billion globally (s. 7).^[51] The British government has previously stated that the ‘regime will be targeted at a small number of firms’.

However, except for the monetary threshold, the SMS criteria are all broadly defined, and could in theory capture as many as 530 companies (as of March 2022, there were 530 companies with more than £1 billion in revenue in the United Kingdom, according to the Office for National Statistics).^[52] Thus, although the government claims that the new regime is aimed at a handful of companies, in practice the CMA will have the power to interfere in a variety of new ways across wide swaths of the economy.

Article 9 of Bill 2768 runs into a similar problem. Granted, it identifies the types of services to which the Bill would apply in a way that the DMCC does not. However, some of the categories envisaged are still very broad: for example, online intermediation services could cover any website that connects buyers and sellers or facilitates transactions between two parties. “Operating systems” are prevalent electronic devices well beyond Apple’s iOS and Google’s Android. Indeed, an operating system is just a program or set of programs of a computer system, which manages the physical resources (hardware), the execution protocols of the rest of the content (software), as well as the user interface. They can be found in many everyday devices, either through graphical user interfaces, desktop environments, window managers or command lines, depending on the nature of the device.

Companies delivering these services, no matter their competitive position, market share, the industry they are a part of, or any other economic or factual considerations, would all be caught by Bill 2768, as long as they fulfilled the (low) R$70 million threshold. The upshot is that the enforcer will be able to apply Bill 2768 against a host of wildly different companies, some of which might not really be in a position to harm competition or misuse their market power. As a consequence, the Bill risks discouraging growth, innovation and, indeed, success, as companies become wary of growing past a certain threshold for fear of being caught in the regulator’s crosshairs. Coupled with a reversal of the burden of proof and the possibility of ignoring efficiencies arguments, the Bill would give the enforcer massive, unchecked powers, which could raise rule of law issues.

This problem can be remedied, at least to some extent, by adding a series of qualitative criteria that may or may not work cumulatively with the quantitative thresholds laid down in the Bill. These criteria should require a showing that the companies in question control access to essential facilities, that such facilities cannot be reasonably replicated, and that access is being denied with the threat that competition on the market may be eliminated (refer to Question 1 for discussion on integrating the essential facilities doctrine into Bill 2768). In addition, Bill 2768 should leverage existing measurements of market power from competition law, such as the ability to control output and increase prices. Quantitative criteria, if used, should be significantly higher and also refer to the number of active users on each platform service covered. “Active user” should in this sense be defined as a user who uses a specific service at least once daily and, at a minimum, once weekly.

Question 12

What did you think of the rules on the Digital Platforms Supervisory Fund in art. 15 of Bill 2768/2022? Is there another way to finance this type of government regulatory activity?

There are many ways of financing governmental regulatory activity that do not require the targeted companies to pay an annual tax. Government agencies are typically financed from the general government budget — and it should be the same for the agency enforcing Bill 2768.

There are at least two issues with the current approach under Art. 15. The first is capture. If an agency’s activity is funded by the regulated companies, this can lead to the capture of the agency by the regulated company and facilitate rent-seeking — i.e., the situation in which a company uses the regulator to gain an unfair advantage over rivals. Second, it also creates an incentive on the part of the agency, and the government, to widen the scope of the targeted companies, as a way to secure more funding and resources. This creates a perverse incentive that does not align with the public interest. It also discourages investment and, in a sense, is tantamount to a racket by the government.

Moreover, to the extent that the Bill operates as a direct and targeted constraint on certain companies’ exercise of their economic liberty and private property rights for the presumed benefit of the public welfare, it seems appropriate that it should be funded by general-revenue funds, apportioned according to current tax policy over the entire tax-paying population.

Question 13

To what extent do you believe that all the problems addressed in Bill 2768/2022 are already adequately addressed by competition law, more specifically by CADE, with the instruments of Law No. 12,529 of 2011?

Please see the response to Question 10.

The fact that the government is asking this question at this stage in the process suggests that perhaps the scope and the particulars of Bill 2768 have not been thoroughly thought out. Bill 2768 should be passed only if it is clear that Brazilian competition law is not up to the task. By comparison, and as indicated in the answer to Question 10 above, virtually all of the conduct in the EU’s DMA has also been addressed through EU competition law — often in the Commission’s favor. However, the EU wanted to codify a set of rules that would ensure that the Commission did not have to litigate cases before the courts and would win every case — or at least the vast majority of cases — against digital platforms. But this decision, which one may or may not agree with, came after at least some experience applying competition law to digital platforms and a determination that the gains of such an approach would outweigh the manifest costs.

Conversely, Brazil’s CADE enjoys much more limited experience in this sense, and Brazil itself presents very different economic realities and consumer interests that may not yield the same cost/benefit analysis. As mentioned above, the only “penalties” CADE has imposed against “digital platforms” resulted from voluntary settlements, meaning there has been limited need to litigate “digital” cases in Brazil. There is a lingering sense that Bill 2768 has been proposed not in response to deficiencies in the existing competition law framework, or in response to identified needs particular to Brazil, but as a response to “global trends” initiated by the EU.

Art. 13 of Bill 2768, for example, provides that mergers by covered companies will be scrutinized pursuant to the general competition law rules applicable to other companies and in other sectors. It is unclear why the same logic could not apply across the board — i.e., to all potentially anticompetitive conduct by targeted companies. Why does some conduct which can be addressed through antitrust law necessitate special regulation, but not others?

Question 14

What problems could be generated for the innovation activity of digital platforms if there is the regulation of digital platforms proposed by Bill 2768/2022? Could this be dealt with in any way within Bill 2768/2022?

Indeed, it is by no means clear that Brazil’s particular circumstances are amenable to an “ex ante” approach similar to that of the EU.

Broad prohibitions and obligations such as the ones imposed by Art. 10 of Bill 2768 risk chilling innovative conduct and freezing technology in place. As the tenth ranked country in the global information technology market and with hundreds of startups in the AI sector, Brazil is a burgeoning market with tremendous potential.^[53] Its 214 million population means that growth trends are poised to continue — and, sure enough, the number of app jobs grew by 54% in 2023 compared to 2019.^[54]

However, static, strict rules such as those envisioned by Bill 2768 can nip the growth of Brazilian startups in the bud by imposing unsurmountable regulatory costs (which would, in any case, benefit incumbents compared to smaller competitors) and banning conduct capable of fostering growth, benefiting consumers, and igniting competition, such as self-preferencing and refusal to deal.

Indeed, both practices can — and often are — socially beneficial. As discussed in Question 8, despite its recent malignment by some policymakers, “self-preferencing” is normal business conduct and a key reason for efficient vertical integration, which avoids double marginalization and allows companies to better coordinate production, distribution, and sale more efficiently — all to the ultimate benefits of consumers. For example, retail services such as Amazon self-preferencing their own delivery services, as in the case of “Fulfilled by Amazon,” gives consumers something they value tremendously: a guarantee of quick delivery. As we have written elsewhere:

Amazon’s granting marketplace privileges to [Fulfilled by Amazon] products may help users to select the products that Amazon can guarantee will best satisfy their needs. This is perfectly plausible, as customers have repeatedly shown that they often prefer less open, less neutral options.^[55]

In a recent report, the Australian Competition Commission recognized as much, stating that self-preferencing is often benign and can lead to procompetitive benefits.^[56] Indeed, there are many legitimate reasons why companies may choose to self-preference, including better customer experience, customer service, more relevant choice (curation), and lower prices.^[57] Thus, banning self-preferencing, or otherwise significantly discouraging companies from engaging in self-preferencing, could hamstring company growth — including by Brazilian companies that are currently in an early stage of development — and impede market entry by companies who could have been innovators.

Similarly, forcing companies to deal with third parties could stifle innovation by incentivizing free-riding and discouraging companies from making investments. Indeed, why would a company innovate or invest if it knows it will then have to share such investments and innovations with passive rivals who have undertaken none of these risks? The consequence is a stalemate where, rather than fighting to be the first to innovate and enjoy the fruits borne of such innovation, companies are rather encouraged to game the system by waiting for others to make the first step and then free riding on their achievements. This essentially upends the process of dynamic competition by artificially rearranging the incentive to innovate and invest vs. the incentive to free ride, reducing the benefits of the former and increasing the benefits of the latter.

It would be catastrophic to drive a wedge in Brazil’s ability to grow its technology sector and innovate — especially considering the country’s vast potential. Indeed, rather than a triumph of regulation over innovation, Brazil should strive to be precisely the opposite.^[58]

Question 15

What would be the practical difficulties of applying this type of legislation contemplated by Bill 2768/2022?

Funds to finance what could be a considerable amount of enforcement are necessary, but not sufficient, to ensure effectiveness. In the EU, the Commission’s DG Competition, one of the world’s foremost and best-endowed competition authorities, has famously struggled to hire the staff necessary to implement the Digital Markets Act. In short, “DMA experts” currently do not exist — and the Commission will either have to train such experts itself or hire them when expertise develops through enforcement. But this creates a chicken-and-egg scenario, where enforcement — or at least good enforcement — cannot happen without good experts, and good experts cannot materialize without enforcement. There is no reason to believe that these considerations do not map onto the Brazilian context.

Brazil faces an additional challenge, however: attracting talent. Unlike in the EU, where posts at the Commission are highly coveted due to the high salaries, perks, and job security they confer, CADE’s resources are more modest and likely cannot compete fully with the private sector. Thus, before passing Bill 2768, the government should be clear on how the law would be enforced, and by whom.

Other issues include the heavy compliance burden of the Bill, which will affect not only the so-called “tech giants” but any company above the modest R$70 million turnover threshold, the difficulties in interpreting the ambiguous prohibitions and obligations contemplated in Art. 10 (and the litigation which may ensue, on which see Question 16), the cost of crafting of adequate remedies within the meaning of Art. 10, and the looming possibility that the Bill will capture procompetitive conduct and stifle innovation. As we have written with respect to ASEAN countries and the possibility of implementing EU-style competition regulation there:

The ASEAN nations exhibit extremely diverse policies regarding the role of government in the economy. Put simply, some of the ASEAN nations seem ill-suited to the far-reaching technocracy that almost inevitably flows from adopting the European model of competition enforcement. Others might simply not have sufficient resources to staff agencies that could, satisfactorily, undertake the type of far-reaching investigations that the European Commission is famous for.^[59]

Question 16

Do you see a lot of room for the judicialization of this type of regulation provided for in Bill 2768/2022? On what devices?

The enforcement of Bill 2768 is likely to lead to substantial litigation, not least because many of the core concepts of the Bill are ambiguous and open to interpretation.

For instance, what does “discriminatory” conduct within the meaning of Art. 10, para. II entail? Can a covered platform treat business users differently based on objective criteria, such as quality, history, and trustworthiness, or must all business users be treated equally? In this sense, it is uncertain whether the specific meaning ascribed to “discriminatory conduct” under competition law applies in this context. Similarly, what does “adequate” use of data collected in the exercise of a firm’s activities mean (paragraph III)? Does paragraph IV of Art. 10 imply that a covered platform can never deny access to business users? Presumably, covered platforms will want to know how and why this general obligation deviates from the narrower essential facilities doctrine under Brazilian competition law.

Art. 11 adds certain caveats to this, such as that intervention should be tailored, proportionate and consider the impact, costs, and benefits. Again, what sort of impact, costs and benefits are relevant — on consumers, business users, the covered platform, society as a whole?

If this is anything to go by, Bill 2768 is likely to be a legally contentious one.

Question 17

Are the definitions in article 6 of Bill 2768/2022 adequate for the purpose of this proposal?

Art. 6 and, indeed, the entire impetus behind Bill 2768, rests on two questionable assumptions:

1. That covered products and services are different from other products or services; and
2. That these products and services are sufficiently similar to be considered (and regulated) as a group.

The former would be more convincing if the remedies contemplated by the Bill, such as non-discrimination, adequate use of data, and access, had not been previously used in other markets and for other products. Granting access on “Fair, Reasonable, and Nondiscriminatory” (“FRAND”) terms is often used in the context of competition law and IP law, both of which apply across industries. The duty to use data “adequately” is generally contemplated by data protection laws, which also apply broadly. The same can be said for access obligations, which are frequent under competition law and in regulated industries (such as telecommunications or railways).

In addition, neither the products and services in Art. 6 of the Bill, the companies that operate them, nor the business models they employ are monolithic. Voice assistants and social media, for instance, are vastly different products. The same can be said about cloud computing, which is not really a “platform” in the sense that, say, online intermediation is. The products and services in Art. 6 themselves are also highly heterogeneous, with a single category encompassing a motley list of products, from e-commerce to online maps and app stores.

The same argument applies to the companies that sell these products and services, which — despite the ubiquitous “Big Tech” moniker — are ultimately very different firms.^[60] As Apple CEO Tim Cook has said: “Tech is not monolithic. That would be like saying ‘All restaurants are the same’ or ‘All TV networks are the same.’”^[61]

For instance, while Google (Alphabet) and Facebook (Meta) are information-technology firms that specialize in online advertising, Apple remains primarily an electronics company, with around 75% of its revenue coming from the sale of iMacs, iPhones, iPads, and accessories. As Amanda Lotz of the University of Michigan has observed:

The profits on those [hardware] sales let Apple use very different strategies than the non-hardware [“Big Tech”] companies with which it is often compared.^[62]

It also means that most of its other businesses — such as iMessage, iTunes, Apple Pay, etc. — are complements that “Apple uses strategically to support its primary focus as a hardware company.” Amazon, on the other hand, is primarily a retailer, with its Amazon Web Services and advertising divisions accounting for just 15% and 7% of the company’s revenue, respectively.^[63]

Even when two “gatekeepers” are active in the same products/service market, they often have markedly different business models and practices. Thus, despite both selling mobile-phone operating systems, Android (Google) and Apple employ very different product-design philosophies. As we argued in an amicus curiae brief submitted last month to the U.S. Supreme Court in Apple v. Epic Games:

For Apple and its users, the touchstone of a good platform is not “openness,” but carefully curated selection and security, understood broadly as encompassing the removal of objectionable content, protection of privacy, and protection from “social engineering,” and the like.… By contrast, Android’s bet is on the open platform model, which sacrifices some degree of security for the greater variety and customization associated with more open distribution. These are legitimate differences in product design and business philosophy.^[64]

These various companies and markets have diverse incentives, strategies, and product designs, therefore belying the idea that there is any economically and technically coherent notion of what comprises “gatekeeping.” In other words, both the products and services that would be subject to Art. 6 of Bill 2768 and those companies themselves are highly heterogeneous, and it is unclear why they are placed under the same umbrella.

Question 18

Instead of pure ex-ante regulation, would any other type of monitoring and/or regulation of digital markets make sense?

A special unit within CADE, operating within the limits of current antitrust laws, should be seriously assessed before rushing to adopt far-reaching, ex-ante regulation in digital markets. Most of the conduct covered by ex-ante regulation in the EU, for example, is spun off from competition law cases. This suggests that such conduct falls within the limits of traditional competition law and can be properly addressed through EU competition law.

Accordingly, a digital unit within CADE would leverage the expertise of staff with a background in applying antitrust law to “digital markets.” Chances are that, if such a unit cannot be formed within CADE, which boasts staff with the expertise that most closely resembles what would be required to enforce Bill 2768, it likely cannot be formed anywhere else — at least not without siphoning off talent from CADE. This would be a mistake, as CADE has a critical role in suppressing behavior that unambiguously harms the public interest, such as cartels (arguably, this is where Brazil should be focusing its resources).^[65] Creating a new unit to prosecute novel conduct with uncertain effects on social welfare at the expense of suppressing conduct that is manifestly harmful does not pass a cost-benefit analysis and would ultimately damage Brazil’s economy.

Question 19

Do you think that the set of solutions described in art. 10 of Bill 2768/2022 are adequate?

It is difficult to answer this question without a clear notion of what Bill 2768 aims to achieve. Adequate for what?

Question 20

Are the set of sanctions provided for in art. 16 of Bill 2768/2022 adequate?

This is also difficult to answer. If the objective is to thwart all proscribed conduct, no matter the consequences for innovation, investment, and consumer satisfaction, then a high fine is called for — and many companies will stop doing business as a result (which will very effectively stop all undesirable behavior – but also all desirable behavior). If raising revenue is the objective, then the amount of enforcement times the level of sanction needs to be low enough to operate not as a bar to behavior but a fee for doing business. We do not know if the level of sanctions in Art. 16 is appropriate for this — nor, we hasten to add, should this ever be the intention of such a law!

On the other hand, if optimal deterrence is the objective, imposing sanctions considerably lower than those in the EU (as a sanction of 2% of the infringing companies’ Brazilian turnover would be) appears reasonable. Fines for antitrust infringements in the EU can be up to 10% of the company’s worldwide turnover; and fines for violations of the DMA can even reach 20%.^[66] But Brazil should not seek to deter investment and innovation to the extent the EU has.

It is, of course, difficult to identify a causal link between competition fines and investment/innovation. But what we do know is this: The pace of economic growth in Europe has lagged that of the U.S. by a significant margin:

Fifteen years ago, the size of the European economy was 10% larger than that of the U.S., however, by 2022 it was 23% smaller. The GDP of the European Union (including UK before Brexit) has grown in this period by 21% (measured in dollars), compared to 72% for the US and 290% for China.^[67]

Meanwhile, none of the world’s 10 largest technology companies, and only two of the 25 largest, are based in Europe.^[68] And the large U.S. and Asian multinationals are spread across the entire technology industry, from electronic components (chips, mobile phones and computers) to app development companies, websites, and e-commerce. There may be many reasons for these discrepancies, but one of them is almost certainly the differences in the economic regulatory environments, including the extent of competition-law overdeterrence.^[69]

Question 21

Article 10 provides for several obligations in a non-exhaustive list on which the regulator could impose other measures. Should an exhaustive list of measures be envisaged?

Exhaustive lists have the advantage of fostering predictability and cabining the enforcer’s discretion, thus limiting rent-seeking, and ensuring that enforcement stays tethered to the public interest. Assuming, of course, that the sort of measures which are envisaged act in the public interest in the first place.

The problem with how Bill 2768 is framed in its current state is that it is too open-ended. It is understandable that Bill 2768 does not want to tie the enforcers’ hands and has opted for bespoke interventions rather than blanket prohibitions and obligations. This is to be welcomed. However, it should not come at the expense of legal certainty, and it must not fail to impose limits on the enforcer’s discretion. This currently does not seem to be the case.

Article 10 thus provides that platform operators will be subject to “amongst others, the following obligations…” It is not clear, from this numerus apertus list, what the enforcer can and cannot do. But the problem is deeper than just Article 10; nowhere in the Bill is it explained what the goals of the new rules are. The proposed redrafting of Article 19-A of Law 9.472 of 16 July 1997 states, in paragraphs III, IV, and V is vague – it does not impose sufficiently clear limiting principles on the Bill’s reach. Indeed, it suggests that the goals of Bill 2768 would be to prevent conflicts of interest, prevent infringements of user’s rights, and prevent economic infringements by digital platforms in areas which are competence of CADE. Article 4 of Bill 2768 includes other goals: freedom of initiative, free competition, consumer protection, a reduction in regional and social inequality, repressing economic power and bolstering social participation. Elsewhere, it is implied that the goal is to diminish “gatekeeper power” (under “Justifications”).

In other words, it is not clear what Bill 2768 doesn’t empower the enforcer to do.

Furthermore, the prohibitions and obligations in Paragraphs I-IV of Art. 10 are similarly opaque. For instance, what is “adequate” use of collected data? (III). Does paragraph IV imply that a targeted platform may never refuse access to their service? In fact, one thing that is missing from Bill 2768 is the ability to escape a prohibition or obligation by demonstrating efficiencies or through an objective justification (such as, e.g., safety and security or privacy).

Clearly, Bill 2768 cannot predict all of the instances in which Art. 10 will be used. But, in order to strike a balance between the enforcer’s nimbleness and the law’s administrability and predictability, it needs to give a more focused account of the Bill’s goals, and how the provisions in Art. 10 help to achieve them. In other words: Articles 3, 4, and 10 need to be much clearer. Otherwise, the Bill risks doing more harm than good to targeted companies, business users, competitors, and ultimately, consumers. The “Justifications” section of the Bill states that it does not wish to impose a “straitjacket” on targeted companies through the imposition of strict ex ante rules. This is reasonable, especially considering the lack of evidence of unambiguous harm. But granting an enforcer like Anatel, which lacks experience in “digital markets,” broadly defined powers to intervene on the basis of equally broad goals amounts to imposing a straitjacket by another name. In a regulatory “panopticon” in which companies are never sure of what is and is not allowed, some might reasonably choose not to take risks, innovate, and bring new products to the market —because they do not wish to risk being subject to fines (Art. 16) and potential structural remedies, like break-ups (Art. 10, paragrafo unico). In other words, they might assume that much more is prohibited than is actually prohibited.

[1] PL 2768/2022, Dispõe sobre a organização, o funcionamento e a operação das plataformas digitais que oferecem serviços ao público brasileiro e dá outras providências, available at https://www.camara.leg.br/proposicoesWeb/fichadetramitacao?idProposicao=2337417.

[2] REGULATION (EU) 2022/1925 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 14 September 2022, on contestable and fair markets in the digital sector and amending Directives (EU) 2019/1937 and (EU) 2020/1828 (Digital Markets Act).

[3] https://www.mercadosdigitais.org/.

[4] Case C-7/97 Bronner, EU:C:1998:569.

^[5] See, e.g., Commissioner Ana Frazão’s majority decision in Procedure No. 08012.003918/2005-14 (Defendant: Telemar Norte Leste S.A.), paras. 60-62, https://tinyurl.com/4dc38vvk.

^[6] See Commissioner Mauricio Maia’s reporting majority decision in Administrative Procedure No. 08012.010483/2011-94 (Defendants: Google Inc. and Google Brasil Internet Ltda.), paras. 180-94; 224-42, https://tinyurl.com/3c9emytw.

^[7] A 2021 report by IBRAC identified the high entry rate into the market of online sales platforms. See IBRAC, Revista do Revista do IBRAC Número 2-2021, available at https://ibrac.org.br/UPLOADS/PDF/RevistadoIBRAC/Revista_do_IBRAC_2_2021.pdf.

^[8] Bronner, Para. 67.

^[9] See Colangelo, G., The Digital Markets Act and EU Antitrust Enforcement: Double & Triple Jeopardy, ICLE White Paper (2022), available at https://laweconcenter.org/resources/the-digital-markets-act-and-eu-antitrust-enforcement-double-triple-jeopardy.

^[10] CADE, Mercados de Plataformas Digitais, SEPN 515 Conjunto D, Lote 4, Ed. Carlos Taurisano CEP: 70.770-504 – Brasília/DF, available at https://cdn.cade.gov.br/Portal/centrais-de-conteudo/publicacoes/estudos-economicos/cadernos-do-cade/Caderno_Plataformas-Digitais_Atualizado_29.08.pdf.

^[11] On the notion that DMA-style rules are “sector-specific competition law,” see Nicolas Petit, The Proposed Digital Markets Act (DMA): A Legal and Policy Review, 12 J. Eur. Compet. Law & Pract. 529 (May 11, 2021).

^[12] See Verizon Communications, Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398 (2003). “Compelling such firms to share the source of their advantage is in some tension with the underlying purpose of antitrust law, since it may lessen the incentive for the monopolist, the rival, or both to invest in those economically beneficial facilities.”

^[13] Hou, L., The Essential Facilities Doctrine – What Was Wrong in Microsoft?, 43(4) International Review of Intellectual Property and Competition Law 251-71, 260 (2012).

^[14] See Williamson, O.E., The Vertical Integration of Production: Market Failure Considerations, 61 Am. Econ. Rev. 112 (1971); Klein, B., Asset Specificity and Holdups, in The Elgar Companion to Transaction Cost Economics, P. G. Klein & M. Sykuta, eds. (Edward Elgar Publishing, 2010), 120–126.

^[15] Commission Decision No. AT.39740 — Google Search (Shopping).

^[16] A. Hoffman, Where Does Website Traffic Come From: Search Engine and Referral Traffic, Traffic Generation Café (Dec. 25, 2018), https://trafficgenerationcafe.com/website-traffic-source-search-engine-referral.

^[17] See Manne, G., Against the Vertical Discrimination Presumption, Concurrences N° 2-2020, Art. N° 94267 (May 2020), https://www.concurrences.com/en/review/numeros/no-2-2020/editorial/foreword.

^[18] On the need for caution when granting a right to access see, for example, Trinko: “We have been very cautious in recognizing such exceptions [to the right of [a] trader or manufacturer engaged in an entirely private business, freely to exercise his own independent discretion as to parties with whom he will deal], because of the uncertain virtue of forced sharing and the difficulty of identifying and remedying anticompetitive conduct by a single firm.”

^[19] United States v. Aluminum Co. of America, 148 F.2d 416, 430 (2d Cir. 1945).

^[20] “Thus, as a general matter, the Sherman Act ‘does not restrict the long recognized right of [a] trader or manufacturer engaged in an entirely private business, freely to exercise his own independent discretion as to parties with whom he will deal.’” United States v. Colgate & Co., 250 U. S. 300, 307 (1919).

^[21] Foremost Pro Color, Inc. v. Eastman Kodak Co., 703 F.2d 534, 545 (9th Cir. 1983) (citations omitted).

^[22] See Manne, G. & B. Sperry, Debunking the Myth of a Data Barrier to Entry for Online Services, Truth on the Market (Mar. 26, 2015), https://truthonthemarket.com/2015/03/26/debunking-the-myth-of-a-data-barrier-to-entry-for-online-services; Manne, G. & B. Sperry (2014). The Law and Economics of Data and Privacy in Antitrust Analysis, 2014 TPRC Conference Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2418779.

^[23] See generally, Grunes, A. & M. Stucke, Big Data and Competition Policy (Oxford University Press, Oxford, 2016); Newman, N, Antitrust and the Economics of the Control of User Data, 30 Yale Journal on Regulation 3 (2014).

^[24] See the examples discussed in Manne, G. & B. Sperry, Debunking the Myth of a Data Barrier to Entry for Online Services, Truth on the Market (Mar. 26, 2015), https://truthonthemarket.com/2015/03/26/debunking-the-myth-of-a-data-barrier-to-entry-for-online-services.

^[25] Lerner, A., The Role of ‘Big Data’ in Online Platform Competition (2014), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2482780.

^[26] Bowman, S. & G. Manne, Platform Self-Preferencing Can Be Good for Consumers and Even Competitors, Truth on the Market (Mar. 4, 2021), https://truthonthemarket.com/2021/03/04/platform-self-preferencing-can-be-good-for-consumers-and-even-competitors.

^[27] C. Goujard, Google Forced to Postpone Bard Chatbot’s EU Launch Over Privacy Concerns, Politico (Jun. 13, 2023), https://www.politico.eu/article/google-postpone-bard-chatbot-eu-launch-privacy-concern.

^[28] M. Kelly, Here’s Why Threads Is Delayed in Europe, The Verge (Jul. 10, 2023), https://www.theverge.com/23789754/threads-meta-twitter-eu-dma-digital-markets.

^[29] Musk Considers Removing X Platform From Europe Over EU Law, Euractiv (Oct. 19, 2023), https://www.euractiv.com/section/platforms/news/musk-considers-removing-x-platform-from-europe-over-eu-law.

[30] Jud, M., Still No Copilot in Europe: Microsoft Rolls Out 23H2 Update, Digitec.ch (Nov. 1, 2023), https://www.digitec.ch/en/page/still-no-windows-copilot-in-europe-microsoft-rolls-out-23h2-update-30279.

^[31] The Future is Bright for Latin American Startups, The Economist (Nov.13, 2023), available at https://www.economist.com/the-world-ahead/2023/11/13/the-future-is-bright-for-latin-american-startups.

^[32] See Distrito, Panorama Tech América Latina (2023), available at https://static.poder360.com.br/2023/09/latam-report-1.pdf.

^[33] The following is adapted from Manne, G., Against the Vertical Discrimination Presumption, Concurrences N° 2-2020, Art. N° 94267 (May 2020) https://www.concurrences.com/en/review/numeros/no-2-2020/editorial/foreword and our comments on the UK’s proposed Digital Markets, Competition and Consumers (“DMCC”) Bill: Auer, D., M. Lesh & L. Radic (2023). Digital Overload: How the Digital Markets, Competition and Consumers Bill’s Sweeping New Powers Threaten Britain’s Economy, 4 IEA Perspectives 16-21 (2023), available at https://iea.org.uk/wp-content/uploads/2023/09/Perspectives_4_Digital-overload_web.pdf.

^[34] H. Singer, How Big Tech Threatens Economic Liberty, The Am. Conserv. (May 7, 2019), https://www.theamericanconservative.com/articles/how-big-tech-threatens-economic-liberty.

^[35] Most of these theories, it must be noted, ignore the relevant and copious strategy literature on the complexity of platform dynamics. See, e.g., J. M. Barnett, The Host’s Dilemma: Strategic Forfeiture in Platform Markets for Informational Goods, 124 Harv. L. Rev. 1861 (2011); D. J. Teece, Profiting from Technological Innovation: Implications for Integration, Collaboration, Licensing and Public Policy, 15 Res. Pol’y 285 (1986); A. Hagiu & K. Boudreau, Platform Rules: Multi-Sided Platforms as Regulators, in Platforms, Markets and Innovation, A. Gawer, ed. (Edward Elgar Publishing, 2009); K. Boudreau, Open Platform Strategies and Innovation: Granting Access vs. Devolving Control, 56 Mgmt. Sci. 1849 (2010).

^[36] For examples of this literature and a brief discussion of its findings, see Manne, G., Against the Vertical Discrimination Presumption, Concurrences N° 2-2020, Art. N° 94267 (May 2020), https://www.concurrences.com/en/review/numeros/no-2-2020/editorial/foreword.

^[37] International Center for Law & Economics, International Center for Law & Economics Amicus Curiae Brief Submitted to the U.S. Court of Appeals for the Ninth Circuit 20-21 (2022), https://tinyurl.com/ywu553vb.

^[38] See generally, Hagiu & Boudreau, Platform Rules: Multi-Sided Platforms as Regulators, supra note 31; Barnett, The Host’s Dilemma, supra note 31.

^[39] Barnett, J., id.

^[40] See Radic, L. and G. Manne, Amazon Italy’s Efficiency Offense, Truth on the Market (Jan. 11, 2022), https://tinyurl.com/2uht4fvw.

^[41] Introduced as Bill 294 (2022-23), currently HL Bill 12 (2023-24), Digital Markets, Competition and Consumers Bill, available at https://bills.parliament.uk/bills/3453.

^[42] Farrell, J., & P. Klemperer Coordination and Lock-In: Competition with Switching Costs and Network Effects, 3 Handbook of Industrial Organization1967-2072 (2007), available at https://www.sciencedirect.com/science/article/abs/pii/S1573448X06030317.

^[43] Bill 2768, “Justifications.” See also Wu, T, The Curse of Bigness: Antitrust in the New Gilded Age, Columbia Global Reports (2018).

^[44] Colangelo, G., The Digital Markets Act and EU Antitrust Enforcement: Double & Triple Jeopardy, ICLE White Paper 2022-03-23 (2022), available at https://laweconcenter.org/wp-content/uploads/2022/03/Giuseppe-Double-triple-jeopardy-final-draft-20220225.pdf.

^[45] See also Caffarra, C. and F. Scott Morton, The European Commission Digital Markets Act: A Translation, Vox EU (Jan. 5, 2021), https://voxeu.org/article/european-commission-digital-markets-act-translation.

^[46] How National Competition Agencies Can Strengthen the DMA, European Competition Network (Jun. 22, 2021), available at https://ec.europa.eu/competition/ecn/DMA_joint_EU_NCAs_paper_21.06.2021.pdf.

[47] For the full study, see https://cdn.cade.gov.br/Portal/centrais-de-conteudo/publicacoes/estudos-economicos/documentos-de-trabalho/2018/documento-de-trabalho-n01-2018-efeitos-concorrenciais-da-economia-do-compartilhamento-no-brasil-a-entrada-da-uber-afetou-o-mercado-de-aplicativos-de-taxi-entre-2014-e-2016.pdf.

^[48] For a detailed overview of CADE’s decisions in digital platforms and payments services, see https://cdn.cade.gov.br/Portal/centrais-de-conteudo/publicacoes/estudos-economicos/cadernos-do-cade/mercado-de-instrumentos-de-pagamento-2019.pdf; https://cdn.cade.gov.br/Portal/centrais-de-conteudo/publicacoes/estudos-economicos/cadernos-do-cade/Caderno_Plataformas-Digitais_Atualizado_29.08.pdf.

^[49] See, e.g., Epic Games, Inc. v. Apple Inc. 20-cv-05640-YGR.

^[50] Staats, J. L., & G. Biglaiser, Foreign Direct Investment in Latin America: The Importance of Judicial Strength and Rule of Law, 56(1) International Studies Quarterly 193–202 (2012), https://doi.org/10.1111/j.1468-2478.2011.00690.x.

^[51] HL Bill 12 (2023-24), Digital Markets, Competition and Consumers Bill, https://bills.parliament.uk/bills/3453.

^[52] Auer, D., M. Lesh, & L. Radic (2023). Digital Overload: How the Digital Markets, Competition and Consumers Bill’s Sweeping New Powers Threaten Britain’s Economy, 4 IEA Perspectives 16-21, available at https://iea.org.uk/wp-content/uploads/2023/09/Perspectives_4_Digital-overload_web.pdf.

^[53] See Dailey, M. Why the US Rejected European Style Digital Markets Regulation: Considerations for Brazil’s Tech Landscape, Progressive Policy Institute (Oct. 2, 2023), pp 5-6, available at https://www.progressivepolicy.org/wp-content/uploads/2023/10/PPI-Brazil-EU-Tech.pdf.

^[54] Id.

^[55] See Radic, L. and G. Manne, Amazon Italy’s Efficiency Offense. Truth on the Market (Jan. 11, 2022), available at https://tinyurl.com/2uht4fvw.

^[56] ACCC, Digital Platform Services Inquiry, Discussion Paper for Interim Report No. 5: Updating Competition and Consumer Law for Digital Platform Services (Feb. 2022), available at https://www.accc.gov.au/system/files/Digital%20platform%20services%20inquiry.pdf.

^[57] Bowman, S. & G. Manne, Platform Self-Preferencing Can Be Good for Consumers and Even Competitors, Truth on the Market (Mar. 4, 2021), https://laweconcenter.wpengine.com/2021/03/04/platform-self-preferencing-can-be-good-for-consumers-and-even-competitors.

^[58] See Portuese, A. The Digital Markets Act: A Triumph of Regulation Over Innovation, ITIF Schumpeter Project (Aug. 24, 2022), available at https://itif.org/publications/2022/08/24/digital-markets-act-a-triumph-of-regulation-over-innovation.

^[59] Auer, D., G. Manne & S. Bowman, Should ASEAN Antitrust Laws Emulate European Competition Policy?, 67(5) Singapore Economic Review 1637–1697, 1687 (2022).

^[60]See Lotz, A. ‘Big Tech’ Isn’t a Monolith. It’s 5 Companies, All in Different Businesses, Houston Chronicle (Mar. 26, 2018), https://www.houstonchronicle.com/techburger/article/Big-Tech-isn-t-a-monolith-It-s-5-companies-12781761.php; see also Chaiehloudj, W. & Petit, N. On Big Tech and The Digital Economy, Competition Forum (Jan. 11, 2021), https://competition-forum.com/on-big-tech-and-the-digital-economy-interview-with-professor-nicolas-petit.

^[61] Asher Hamilton, I. Tim Cook Says He’s Tired of Big Tech Being Painted as a ‘Monolithic’ Force That Needs Tearing Apart, Business Insider (May 7, 2019), https://www.businessinsider.com/apple-ceo-tim-cook-tired-of-big-tech-being-viewed-as-monolithic-2019-5.

^[62] Lotz, 2018.

^[63] G. Cuofano, Amazon Revenue Breakdown, Four Week MBA (Aug. 10, 2023), https://fourweekmba.com/amazon-revenue-breakdown.

^[64] International Center for Law & Economics, International Center for Law & Economics Amicus Curiae Brief Submitted to the U.S. Supreme Court (2022), available at https://laweconcenter.org/wp-content/uploads/2023/11/ICLE-Amicus-Apple-v-Epic-SCt-10.27.23-FINAL.pdf.

^[65] See Zúñiga, M. Latin America Should Follow Its Own Path on Digital-Markets Competition, Truth on the Market (Nov. 7, 2023), https://truthonthemarket.com/2023/11/07/latin-america-should-follow-its-own-path-on-digital-markets-competition.

^[66] As pointed out in Question 10, however, there is a risk of double jeopardy considering that some of the conduct caught by Bill 2768 might also be covered by Brazilian competition law. In such cases, the 2% would be compounded by the penalties contemplated under Act 12.529/11, the Brazilian competition law, and the level could easily be too high.

^[67] Weekly Foreign Policy Report No. 1329: A Europe Vassal to the US?, Política Exterior (Jun. 26, 2023) https://www.politicaexterior.com/articulo/una-europa-vasalla-de-eeuu.

^[68] See, e.g., 100 Biggest Technology Companies in the World, Yahoo Finance (Aug. 23, 2023), available at https://finance.yahoo.com/news/100-biggest-technology-companies-world-175211230.html.

^[69] See, e.g., Weekly Foreign Policy Report No. 1329: A Europe Vassal to the US?, Política Exterior (Jun. 26, 2023) https://www.politicaexterior.com/articulo/una-europa-vasalla-de-eeuu.

Executive Summary

This study assesses the likely consequences of implementing the Credit Card Competition Act (CCCA), which proposes to require issuers of most Visa and Mastercard branded credit cards in the United States to include a second network on their cards, and to allow merchants to route transactions on a network other than the primary network branded on the card.

Proponents of the Credit Card Competition Act (CCCA) claim that it would “enhance credit card competition and choice in order to reduce excessive credit card fees.” In fact, by forcing most U.S. credit-card issuers to include a second network on all their cards, the CCCA would remove the choice of network from the issuer and cardholder, and place it in the hands of the merchant and the acquiring bank.

There is some uncertainty as to the legislation’s anticipated effects, as nothing quite like it has ever been implemented anywhere in the world. We can, however, make some inferences based on the known effects of prior regulations driven by similar motives, in the United States and in such jurisdictions as Europe and Australia.

The primary U.S. payment-card networks—Visa, Mastercard, American Express, and Discover—constantly vie with one another to attract customers, investing billions of dollars in innovations that improve the user experience and reduce fraud and theft.

At the same time, hundreds of banks and credit unions compete to offer a broad range of credit cards to American consumers, choosing the network for each card based on the fit between the network’s terms, the card’s purposes, and its intended market.

Credit cards offer numerous benefits, including access to credit (interest-free, if paid in full by the due date), fraud protection, and chargebacks. Many also offer purchase insurance, fee-free international transactions, and consumer rewards like loyalty points and cash back.

Many rewards cards are co-branded with partners such as airlines, hotels, and retailers. The relationship between partners and card issuers is highly synergistic, with issuers generating revenue—due to increased use and associated interchange fees—while partners receive payments for rewards, marketing, and other ancillary benefits (such as lounge access, in the case of airlines). For the top six U.S. airlines alone, these deals represent more than 5% of total revenue—and five times their net revenue.

Credit-card rewards, including cash back and travel points, have become an important part of many consumers’ budgeting decisions. Indeed, it is not uncommon for consumers to have two or three different rewards credit cards, enabling them to choose which to use at time of a purchase based, at least in part, on the rewards they receive from any particular card.

While the CCCA would likely reduce the interchange fees paid by acquiring banks to issuing banks, overall bank fees are unlikely to fall dramatically. Rather, banks would shift fees from interchange to other sources of revenue, including late fees and interest.

The reduction in interchange fees would almost certainly significantly reduce rewards and other benefits to cardholders, as happened when price controls were imposed on debit cards following the implementation of a provision of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 known as the “Durbin amendment,” after sponsoring Sen. Richard Durbin (D-Ill.), who is also lead sponsor of the CCCA. The reduction in interchange fees, in turn, would make certain types of cards less viable. As such, the CCCA would reduce choice for consumers.

Exempted card issuers—especially those of the large three-party networks, American Express and Discover—would likely benefit from the CCCA, as they would still be able to offer rewards and the security of their networks would not be affected.

Merchants who partner with exempted three-party card issuers also would almost certainly benefit, at the expense of other merchants whose co-branded cards are issued by banks that are covered by the legislation. For example, Delta Airlines, which has a card co-branded with American Express, would benefit at the expense of all other airlines. Merchants that co-brand with a three-party card would not only benefit from higher merchant fees, but also from customers switching to receive higher levels of loyalty rewards. Moreover, those who currently spend the most on their co-branded cards would likely be most motivated to switch.

Given the relatively low margins of the U.S. airline industry and the significant proportion of revenue that loyalty rewards represent, the combination of reduced loyalty revenue and reduced customer revenue could be absolutely devastating for the industry (except, as noted, for Delta).

To make matters worse, the CCCA may also affect many airlines’ costs of capital. For example, a reduction in expected revenue from the sale of rewards could result in credit rating agencies downgrading the bonds that United and American Airlines’ rewards-program subsidiaries issued during the COVID-19 pandemic. That could trigger covenants requiring the parent companies to post additional capital, which would, in turn, increase the parents’ capital costs.

In general, the combination of reduced revenue and reduced loyalty-program memberships—leading to lower revenue from higher-value customers—would reduce airlines’ expected future profitability, which would increase capital costs. This may not pose a problem in periods when demand for air travel is high. In a downturn, however, it could result in a bankruptcy—previously avoided due to the airline’s ability to securitize its loyalty program.

One potential outcome is that bank issuers and airlines choose to cancel their co-branded agreements by mutual consent, so that the airlines could make similar arrangements solely with three-party card networks. While this would clearly be beneficial for those three-party networks, and could mitigate the harm to the airlines, it would be enormously costly, and the losers would be issuers, four-party networks, cardholders (especially those with lower credit scores who did not qualify for the three-party-network cards), and the U.S. economy as a whole.

It is also possible that issuers will do what they appear to have done in the EU: increase interest rates and late fees so that they can continue to offer some level of rewards. In that case, the CCCA would have brought about what some critics of credit-card rewards have previously falsely accused issuers of doing: using credit cards to transfer wealth from lower-income, lower-spending consumers who maintain a revolving balance to higher-income, higher-spending consumers who pay off their balances every month.

Either way, the CCCA effectively picks winners and losers. The winners will be three-party cards—especially American Express—and merchants that co-brand with those cards, such as Delta (and their customers), as well as big-box retailers. The losers will be Visa, Mastercard, the other airlines, the card issuers, and their customers. Overall, merchants are also likely to lose, as consumers spend less, which could translate into lower rates of economic growth. Unfortunately, the number and scale of those who lose is likely to be far greater than the number and scale of those who win.

I.        Introduction

Over the past 20 years, payment cards have become increasingly vital to the U.S. economy, largely replacing checks as the preferred means of making a whole range of payments. Underpinning this shift have been innovations in payments technologies that have made them quicker, more convenient, more secure, and less costly for both consumers and merchants.1F[1] These innovations have been driven by competition:

• The primary U.S. payment-card networks—Visa, Mastercard, American Express and Discover—constantly vie with one another to attract and retain customers, investing billions of dollars in innovations that improve the user experience and reduce fraud.
• At the same time, hundreds of banks and credit unions compete to offer a wide range of credit cards to American consumers. Those issuers choose the four-party network for each card, based on the fit between the network’s terms, the card’s purposes, and its intended market.
• Meanwhile, the two major three-party networks—American Express and Discover—compete both with each another and with the large issuers and the four-party networks over which they operate.

A.      Counterparty, Default, and Collection Risk

Credit-card issuers guarantee payment to merchants, so long as those merchants comply with the terms and conditions set by the card network.[2] In so doing, credit cards provide a means of payment that has lower counterparty risk for the merchant than checks. At the same time, card issuers effectively assume the risk of default and collection.

Back in 2010, Sen. Richard Durbin (D-Ill.) himself recognized that operating credit cards is an expensive enterprise that entails counterparty, default, and collection risk, which is why credit cards were excluded from the original Durbin amendment. As he noted at the time:

About half of the transactions that take place now using plastic are with credit cards, and there is a fee charged—usually 1 or 2 percent of the actual amount that is charged to the credit card. It is understandable because the credit card company is creating this means of payment. It is also running the risk of default and collection, where someone does not pay off their credit card. So, the fee is understandable because there is risk associated with it.[3]

B.      Understanding Interchange Fees

For early card-payment systems, offering a means of payment and being exposed to counterparty, collection, and default risk were pretty much the core features of the product. This is because there were only two parties: the merchant and the consumer. The “card” (a metal plate) enabled merchants to maintain a record of credit provided to regular customers, who would then settle up at the end of the month.3F^[4]

So, had Sen. Durbin been referring to the Charge Plate—or to its modern equivalent, which are merchant-issued charge cards—his characterization of the costs would have been largely correct. But nearly all modern payment networks are either three- or four-party systems that are fundamentally more complex.

1.        Three- and four-party cards

In the 1950s, Diners Club and then American Express both established “three-party” systems, which enabled consumers to use the same card at multiple merchants.4F^[5] In a three-party system, the card issuer pays merchants directly, and bills and collects from cardholders directly.5F^[6]

The following decade, several organizations developed “four-party” systems, which have four main parties: issuer, consumer, merchant, and acquirer. The issuer contracts with the consumer, providing the card, issuing bills, etc. The acquirer contracts with the merchant, making payment. The rules of the system are set by the network operator, which also facilitates settlement between the issuer and the acquirer, and monitors for fraud and other abuse.6F^[7] Visa and Mastercard are the primary global four-party networks.

2.        Two-sided markets

One of the major challenges faced by both three- and four-party payment systems is to persuade both merchants and consumers of their value. If too few merchants accept a particular form of payment, consumers will have little reason to hold it and issuers will have little incentive to issue it. Likewise, if too few consumers hold a card, merchants will have little reason to accept it.

Conceptually, economists describe such scenarios as “two-sided markets”: consumers are on one side, merchants on the other, and the payment system acts as the platform that facilitates interactions between them.7F^[8] While payment cards are a prominent example of a two-sided market, there are many others, including newspapers, shopping malls, social-networking sites, and search engines. Indeed, the rise of the internet has made two-sided markets practically ubiquitous.

All platform operators that facilitate two-sided markets face essentially the same challenge: how to create incentives for participation on each side of the market to maximize the joint net benefits of the platform to all participants—and to allocate costs accordingly.8F^[9] Thus, the platform operator can be expected to set the respective prices charged to participants on each side of the market to achieve this maximand.9F^[10] If the operator sets the price too high for some consumers, they will be unwilling to use the platform; similarly, if the operator sets the price too high for some merchants, they will not be willing to use the platform. As the U.S. Supreme Court put it:

To optimize sales, the network must find the balance of pricing that encourages the greatest number of matches between cardholders and merchants.^[11]

3.        Transaction fees

This brings us to transaction fees, which are the primary mechanism that credit-card-network operators use to balance the market. In three-party systems (American Express and Discover), the card-network operator acts as both issuer and acquirer, and charges merchants a card-processing fee (typically a percentage of the transaction amount) directly. In four-party systems, the issuer charges the acquirer an “interchange fee” (set by  the networks) that is then incorporated into the fees those acquirers charge to merchants (called a “merchant-discount rate” in the United States). The schematics in Figure 3 show how these different systems operate.

The interchange fees charged on four-party cards vary by location, type of merchant, type and size of transaction, and type of card. An important factor determining the size of interchange fee charged to a particular card is the extent of benefits associated with the card—and, in particular, any rewards that accrue to the cardholder.

The various three- and four-party payment networks have been engaged in a decades-long process of dynamic competition, in which each has sought—and continues to seek—to discover how to maximize value to their networks of merchants and consumers. This has involved considerable investment in innovative products, including more effective ways to encourage participation, as well as the identification and prevention of fraud and theft.^[12]

It has also involved experimentation with differing levels of transaction fees. The early three-party schemes charged a transaction fee of as much as 7%.15F^[13] Competition and innovation (including, especially, innovation in measures to reduce delinquency, fraud, and theft) drove those rates down. For U.S. credit cards, interchange fees range from about 1.4% to 3.5%, while the average is approximately 2.2%.18F^[14]

In general, economists have concluded that the “optimal” interchange fee is elusive, and that the closest proxy is to be found through unforced market competition. They have therefore cautioned against intervention without sufficient evidence of a significant market failure.25F^[15]

C.      Regulation: In Whose Interests?

Despite these cautions, governments have intervened in the operation of payment systems in various ways. As we have documented previously, many of these regulations have slowed the shift toward more innovative, quicker, and more convenient payment systems, while also reducing other benefits and harming, in particular, poorer consumers and smaller merchants.2F[16]

Introduced in June 2023 by Sens. Richard Durbin (D-Ill.), Roger Marshall (R-Kan.), Peter Welch (D-Vt.), and J.D. Vance (R-Ohio), the Credit Card Competition Act of 2023[17] would continue this trend, to the detriment of consumers and businesses. As this paper documents, co-branded cards generate significant revenue for the merchants whose brand appears on the card. As Section II documents, this appears to be particularly true for airlines. While many other merchants also have valuable co-branded agreements, they generally represent a much lower proportion of total revenue. Hence, assessing the potential effect of the CCCA on airline co-branded credit cards—and on the airlines themselves—is particularly important.

As documented in Section IV, there are broadly two potential outcomes of the CCCA with respect of U.S. airlines:

• Businesses could implement workarounds that minimize the law’s effects. These workarounds are not costless; among other things, they would entail rewriting hundreds of millions of contracts. Issuers, merchants, and consumers would bear those costs. There would also be a significant redistribution of revenue and profits away from the largest four-party card issuers and payment networks and toward the two major three-party networks—perhaps especially American Express. And there would be a smaller redistribution of revenue and profits away from the larger airlines that currently have co-branded cards with Visa and Mastercard (especially American, United, Southwest, Alaska, and JetBlue) toward Delta, which is the one major domestic airline that has a co-branded card with American Express.
• If businesses are unable to implement adequate workarounds, the act’s effects could be much more severe. Most significantly, with the exception of Delta, the major airlines could potentially lose billions of dollars in revenue, mainly because of the reduction in revenue from co-branded cards, but also because some proportion of flyers would likely switch to Delta to take advantage of the more attractive benefits on Delta’s existing co-branded credit card. This, in turn, would affect airlines’ ability to operate some marginal routes, perhaps leading to a spiral of defections to Delta, which would become a huge beneficiary, as it would be relatively more profitable and attract additional fliers.

While the second outcome would clearly be worse, in both cases, Americans would have choices taken away, costs would increase, and economic growth would be adversely affected. Moreover, far from reducing merchants’ costs, most merchants would be adversely affected, as the costs of acquiring credit cards would not fall and could, indeed, rise (and, of course, merchants with co-branded loyalty-rewards cards would suffer substantial revenue losses). In short, there is basically no scenario in which the Credit Card Competition Act is actually good for competition, American consumers, or the U.S. economy as a whole.

D.     Overview of the Study

The study proceeds as follows:

• Section II discusses the nature and economics of loyalty-rewards programs, with a particular focus on airline-rewards programs. It then explains co-branded credit cards and describes some of the major airline co-branded credit-card partnerships, including their likely revenue.
• Section III provides a brief overview of the CCCA.
• Section IV considers some of the primary examples of interchange-fee price controls and routing regulations that have been implemented in the United States and other jurisdictions.
• Section V considers, in detail, the potential effects of the CCCA. It discusses various implementation scenarios and the likely effects of these scenarios on the rewards received by holders of airline co-branded cards, on the behavior of those cardholders, and on the airlines themselves.
• Section VI offers some concluding remarks.

II.      Airline Loyalty-Rewards Programs and Co-Branded Credit Cards

Loyalty-rewards programs have existed for hundreds of years. The first documented program in the United States was established in 1793 by a merchant in Sudbury, New Hampshire, who gave away copper tokens to customers, which could be redeemed for goods.[18] Over time, programs became more sophisticated, with copper tokens replaced, first, by stamps and, later on, by plastic cards with magnetic stripes that encoded the owner’s account information (reward information being recorded on a central database that could be accessed using the card, enabling rewards to be deposited or used). These days, rewards are mostly held in online accounts and accessed via websites and mobile apps, although cards are often still distributed—albeit mainly symbolically.

While we are mainly concerned here with airlines loyalty-rewards programs, and specifically with the role of credit cards co-branded by those programs, it helps to have a more general appreciation of the nature and function of loyalty-rewards programs. Toward that end, this section begins with a basic explanation of the economics of loyalty-rewards programs. It then explores the nature and function of credit-card reward programs, before discussing airline/credit-card co-branded reward programs in more detail.

A.      The Economics of Loyalty-Rewards Programs

Loyalty-rewards programs function primarily as marketing tools to encourage customers to become and remain loyal to a particular merchant. Program participants typically receive points toward rewards each time they make a purchase associated with the program, creating incentives to buy goods and services from that merchant.

These incentives are enhanced by structuring the programs in tiers and making them time-limited, so that participants who purchase more goods or services in a particular period receive higher levels of rewards. Such features are prominent in airline-reward programs, which typically offer inducements to participants in the form of upgrades, waived baggage fees, and use of airport lounges, which become available upon spending a certain amount over the course of a year.[19]

Loyalty-reward programs that distribute specific goods or services in return for reward points, coupons, or stamps likely benefit from the ability to purchase goods or services at a bulk discount.[20]

Merchants may also use rewards redemptions as a means to practice price discrimination, offering specific goods and services to reward-program participants for reduced reward redemptions. For example, airlines typically offer seats for fewer reward points during off-peak periods. Such discounts reduce the marginal cost of the rewards program, enabling merchants to make use of otherwise-unfilled capacity or to sell bulk-purchased goods, while simultaneously providing additional benefits to loyal customers.

Card-based and digital (i.e., app-based or online) reward programs also collect data on the purchasing habits of program participants. As a result, program operators and partners can target marketing at specific participants and more effectively build longer-term customer relationships with them.

B.      Airline-Rewards Programs

American Airlines established the first airline loyalty-rewards program, AAdvantage, in 1981.[21] The other major carriers soon followed suit, realizing that such programs can be an effective means to offer incentives for loyalty. The standard loyalty-rewards program was boosted in 1982 when American Airlines introduced a “gold” tier for higher-value customers.[22] Again, other airlines followed suit, and most have since developed multiple tiers. The evidence shows that airline loyalty-reward schemes are highly effective ways to attract and retain high-value customers.[23]

The value of airline loyalty-reward programs was demonstrated in an unusual way during the COVID-19 pandemic. The collapse in demand for air travel caused more than 40 airlines around the world to file for bankruptcy.[24] Initially, some U.S. carriers issued bonds with very high coupons, as they hemorrhaged cash.[25] Then, in June 2020, United Airlines created a separate bankruptcy-remote entity for its rewards programs, and used it as collateral to issue $5 billion in bonds at a more favorable rate than the airline itself would have received.[26] American and Delta took the same approach.[27]

C.      Credit-Card Reward Programs

Credit-card rewards programs are similar in many elements of their basic operation to other reward programs. Card users receive rewards either in the form of cashback or points (or “miles”) that can be redeemed for various goods and services (the specific goods and services available vary, depending on nature of the rewards-program operator and any partners or affiliates).

Many card issuers offer credit cards that are co-branded with merchants, ranging from retailers to hotels. Among the most popular cards are those co-branded with airlines. Before delving into the particulars of airline co-branded cards, however, it is worth briefly considering the mechanics of co-branded cards in general.

Each co-branded card offering exists by way of an agreement between the card issuer and the co-brand entity. This agreement typically specifies the amount the card issuer will pay the co-brand entity for the purchase of loyalty-reward points, as well as marketing opportunities. These agreements enable issuers, in turn, to make further agreements with cardholders, offering them specific rewards in return for specific spending amounts.

By offering rewards, card issuers provide card holders with incentives to use their card. Meanwhile, the rewards themselves also create loyalty toward the co-brand entity. And the co-brand entity is typically able to adjust the redemption rate of loyalty rewards in order to encourage the use of rewards in ways that reduce the marginal cost of the rewards redemption to the co-brand entity. That, in turn, enables the co-brand entity to offer rewards to card issuers at a discount. In this way, rewards programs can generate significant profits for co-brand entities and issuers, while generating loyalty to the brand and the card for cardholders.

Credit-card-based reward programs can be a highly effective way both to increase the use of cards and to enhance customer loyalty. Survey data demonstrate the effectiveness of rewards programs as a means of encouraging loyalty. A 2015 survey by Technology Advice of U.S. shoppers found that more than 80% of respondents said they were more likely to shop at stores that offered loyalty programs.[28]

Credit-card issuers, in turn, fund the programs partly by charging annual fees to users and partly by charging interchange fees to merchants.

Merchants undoubtedly benefit from credit-card-reward programs both directly and indirectly. Direct benefits come from the ability to target marketing to reward-program members through discounts, additional rewards, and other inducements. As noted, card-based rewards programs enable merchants to customize marketing to specific individuals and groups based on information gathered through card use about their purchasing habits. This can result in a substantial increase in spending per-transaction (known as “ticket lift”).

Research by Mastercard, for example, found that international travelers to the United States who were offered incentives to shop at certain merchants spent four times as much on their cards as cardholders not redeeming such offers.[29] Indirect benefits come from increased use of credit cards in general, which leads to increased spending, due to reduced liquidity constraints, as well as reduced transaction costs and better transaction management.

Credit-card issuers also benefit from credit-card rewards programs, through additional card uptake and usage, as well as from fees charged to merchants and third-party reward-card operators for transaction-related information that better enables them to target marketing efforts.[30]

Arguably the greatest beneficiaries of reward programs, however, are consumers with reward credit cards. Such consumers benefit directly, both from the rewards themselves and from the various additional inducements offered by merchants and card issuers as part of marketing efforts. A survey by Ipsos conducted at the end of 2020 found that 60% of Americans consider credit-card rewards to be “very important” for them, while over half said the prospect of rewards influences their purchasing decisions.[31] Meanwhile, a more recent survey by WalletHub found that 80% of respondents said that inflation had made them more interested in credit-card rewards.[32]

Moreover, due to the better targeting of these inducements made possible by the use of individual transaction data, owners of rewards credit cards likely receive offers that are more relevant than poorly differentiated mass marketing and advertising. In the WalletHub survey, 58% of Americans said they go out of their way to spend at merchants who offer additional credit-card rewards.[33]

D.     Airline/Credit-Card Co-Branded Reward-Program Partnerships

Many merchants with loyalty-rewards programs partner with affiliated (non-competing) merchants to expand their program’s reach. Airlines notably partner with providers of related travel services, such as hotels and car-rental services, offering additional loyalty-rewards points in return for spending dollars at those partners. The partners in these programs purchase the loyalty-rewards points from the airlines, thereby generating additional revenue for the airline.

1.        The value of airline loyalty-reward programs

In 2022, loyalty-rewards programs represented 7.6% of total revenue for the top six U.S. domestic airlines (“loyalty income” column in Table 1). Given the airlines’ relatively thin profit margins (“net income” column in Table 1), this revenue is clearly important even in good times. Indeed, in 2019, the net cash income of the loyalty-rewards programs for the three largest U.S. airlines was $7.8 billion and the margin on those programs ranged from 39% to 53%.[34]

[35]

But loyalty-rewards income can be even more important during downturns. During the 2009-2010 recession, both American Airlines and Delta reported pre-selling $1 billion of loyalty rewards to their co-branded credit-card issuers (Citibank and American Express, respectively).[36] And during the COVID-19 pandemic, the airlines were essentially kept afloat by their loyalty-rewards programs, in general, and their co-branded cards, in particular.

In 2020, for example, American Airlines sold $3.65 billion of loyalty rewards, of which $2.9 billion came from sales to co-branded cards and other partners, resulting in adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) for the loyalty-rewards program of $2.1 billion.[37] It is noteworthy that those partner-rewards sales were only 25% lower in 2020 than in 2019, suggesting that co-branded cards were responsible for about 70% of the total.[38] Meanwhile, Delta, United, and American raised more than $10 billion by issuing debt backed by their loyalty programs, enabling them to avoid bankruptcy.[39]

2.        The value of credit-card co-branded partnerships

For airlines, the most significant loyalty-reward partnership is with credit-card issuers.[40] While the airlines do not usually break out the numbers specifically for co-branded cards, they are clear in their annual reports about the importance of their partnerships with credit-card issuers. Consider the following four examples:

• American Airlines’ 2022 annual report noted that: “During 2022 and 2021, cash payments from co-branded credit card and other partners were $4.5 billion and $3.4 billion, respectively.”[41]
• United Airlines’ 2022 annual report noted that: “Other operating revenue increased $664 million, or 31.8% [to 2.75 billion], in 2022 as compared to 2021, primarily due to an increase in mileage revenue from non-airline partners, including credit card spending recovery with our co-branded credit card partner….”[42]
• Delta Airlines’ annual report noted that revenues from its loyalty program “are mainly driven by customer spend on American Express cards and new cardholder acquisitions.” Meanwhile, the company’s accounting of “miscellaneous income” was “primarily composed of lounge access, including access provided to certain American Express cardholders, and codeshare revenues.” In 2022, income from the loyalty program was $2.58 billion, while miscellaneous revenue was $894 million.[43] In total, the two revenue streams represented $3.47 billion.
• In 2022, Southwest declared $3.03 billion in “passenger loyalty” related revenue.[44] As the company’s annual report explained: “Passenger loyalty – air transportation primarily consists of the revenue associated with award flights taken by loyalty program members upon redemption of loyalty points.” Southwest accounts for loyalty points on an accrual basis as a liability, which becomes “revenue” when they are spent. Southwest separately accounts for “other revenues” which “primarily consist of marketing royalties associated with the Company’s co-brand Chase® Visa credit card, but also include commissions and advertising associated with Southwest.com ®.”[45] It notes: “The Company recognized revenue related to the marketing, advertising, and other travel-related benefits of the revenue associated with various loyalty partner agreements including, but not limited to, the Agreement with Chase, within Other operating revenues. For the years ended December 31, 2022, 2021, and 2020 the Company recognized $2.1 billion, $1.4 billion, and $1.1 billion, respectively.”[46]

As these descriptions indicate, revenues to airlines from co-branded cards are a combination of loyalty rewards, which issuers purchase from the airlines and then allocate to cardholders in accordance with the terms of agreements between the issuers and cardholders; payments for marketing, which includes such items as sending promotional materials to the airlines’ lists of loyalty-rewards members; and payments for ancillary benefits, such as lounge access for some cardholders.

Previous estimates indicate that the proportion of “loyalty revenue” attributable to co-branded credit cards is in the 70% to 80% range.[47] At the lower end of that range (70%), the top six airline co-branded cards would have generated just over $10 billion in value in 2022. Plausibly, the number is somewhat higher. As such, revenue from co-branded cards would represent at least 5% of the operating revenue of the six largest airlines and five times those airlines’ net revenue.

Per the discussion above about the beneficiaries of co-branded reward programs, it seems reasonable to infer that airline co-branded reward cards are highly valued by consumers, airlines, the partners, and the card issuers.

III.    The Credit Card Competition Act

The Credit Card Competition Act of 2023 (CCCA) was introduced in the U.S. Senate on June 7, 2023, by Sens. Richard Durbin (D-Ill.), Roger Marshall (R-Kan.), Peter Welch (D-Vt.), and J.D. Vance (R-Ohio). If enacted, the bill would direct the Federal Reserve Board to promulgate regulations to prohibit banks with assets of $100 billion or more from issuing credit cards[48] that could be used with either (1) only one payment network, (2) only two affiliated payment networks,[49] or (3) only the two payment networks with the “largest market share.”[50] The bill also directs the Federal Reserve Board to promulgate rules prohibiting credit-card processors from limiting merchants’ ability to choose which network they use to route a payment.[51] Furthermore, it would effectively require interoperability of credit-card “tokens.”

While the bill does not explicitly name Visa or Mastercard, they are clearly its primary target. The legislation defines “largest market share” by number of cards issued, which is far larger for both Visa and Mastercard than for any three-party network (i.e., American Express and Discover), primarily because of the intense competition among banks to supply cards.[52] In addition, the Federal Reserve Board would be required to review market share every three years and, if the identities of two largest networks have changed, then the third requirement would no longer apply.[53] As if that weren’t clear enough, the legislation also states that “The regulations … shall not apply to a credit card issued in a 3-party payment system model.”[54]

A.      Prima Facie, Would the CCCA Achieve Its Aims?

In his summary of the act, Sen. Durbin claims:

[T]he giant banks that issue the overwhelming majority of Visa and Mastercard credit cards would have to choose a second competitive network to go on each card, and then a merchant would get to choose which of those networks to use to process a transaction. This competition and choice between networks would incentivize better service and lower cost; in fact, for more than a decade, federal law has required debit cards to carry at least two debit networks and this requirement of a choice of debit networks has fostered increased competition and innovation in the debit network market and has helped hold down fees.

That is, to say the least, an optimistic appraisal of the proposed legislation. While it is highly plausible that the CCCA would, if enacted, lead to a reduction in interchange fees, it appears highly unlikely that it offers incentives for better service. Indeed, the opposite is far more likely. The reason is asymmetric counterparty risk and, specifically, the lack of adequate incentives on the part of larger merchants and acquirers to choose networks that manage fraud risk. This is a problem that Todd Zywicki and I discuss at length in our recent paper on the regulation of routing in payment networks.[55] As we note there:

[E]ach party to a transaction has somewhat different incentives regarding the choice of network. In general, the card issuer and cardholder both have strong incentives to route payments over the main branded network associated with the card, thereby ensuring the use of all the security and anti-fraud protections available from an EMV card, including 3DS for online transactions and the ability for cardholders to place temporary holds on their cards. Some merchants also have incentives to route over the main branded network, especially smaller merchants selling higher-value goods online, given the potential for very expensive chargebacks from unauthorized transactions. However, many other merchants, especially larger high-volume merchants, would have incentives to use the lowest cost routing, especially those that are able to take advantage of the EMV chip and PIN for POS transactions, and those that have their own machine-learning-based fraud monitoring systems that enable them to reduce potential chargebacks on their own. Finally, acquirers generally have less incentive to avoid fraud and stronger incentives to route transactions over the least-cost route.

Since the CCCA would shift the choice of network from the issuer to the merchant and/or acquirer, and since those parties generally have weaker incentives to route transactions over more secure networks with better fraud detection, the likeliest effect is that the CCCA would reduce investments in fraud prevention. As we also noted in the paper on regulating routing, mandating “competition” over routing would cause data fragmentation, with some transactions being routed over the primary network while others are routed over the secondary network. The end result is that the networks’ fraud-detection algorithms would be less effective.[56] Thus, at least when it comes to fraud prevention, the CCCA would likely result in worse service, not better.

B.      The Effect of the CCCA on Airline Co-Branded Rewards Cards

As noted, for reasons explained in Section II, this paper is primarily interested in the effect of the CCCA on airline co-branded rewards cards. Subsequent sections draw on evidence regarding the effects of other interchange-fee regulations, both in the United States and around the world. As a prelude, here is what American Airlines said in its 2022 annual report about the legislation’s potential implications (referring to a near-identical bill that was introduced in the 117^th Congress):

We may also be impacted by competition regulations affecting certain of our major commercial partners, including our co-branded credit card partners. For example, there has previously been bipartisan legislation proposed in Congress called the Credit Card Competition Act designed to increase credit card transaction routing options for merchants which, if enacted, could result in a reduction of the fees levied on credit card transactions. If this legislation were successful, it could fundamentally alter the profitability of our agreements with co-branded credit card partners and the benefits we provide to our consumers through the co-branded credit cards issued by these partners.[57]

IV.    Lessons from Other Interchange Regulations

Over the past four decades, jurisdictions across the world have imposed a range of regulations on payment cards.[58] The most common of these have been price controls on interchange fees. Because three-party card networks are closed loop, there is technically no “interchange” fee and, in many but not all cases, regulations have been interpreted as not applying to them.[59] Some jurisdictions have also imposed other regulations, of which the most relevant for the current analysis is the Durbin amendment’s routing requirements. This section discusses evidence of the effects of these two types of regulation in order to provide insights into what might be expected from the CCCA. (For additional details, see our recent literature review.[60])

A.      Price Controls

In every jurisdiction that has introduced price controls on interchange fees, issuing banks have responded by adjusting their offerings. In the case of credit cards, this has typically meant some combination of reduced card benefits (rewards, insurance, and so on); increased annual fees; and/or increased interest rates. In the case of debit cards, it has means reduced card benefits, increased bank-account fees, and overdraft charges. Some notable examples:

1.        Australia: Fewer rewards, higher annual fees, and companion cards

When the Reserve Bank of Australia (RBA) imposed price controls on credit-card interchange fees in 2003, it made clear that one of its objectives was to reduce the use of credit cards by making them less attractive as a payment solution for consumers.[61] The ploy appears to have worked, as annual fees for rewards credit cards rose, and the rate of rewards fell significantly:

• Between 2002 (the year before the regulation came into effect) and 2004, the annual fee on a “standard” rewards credit card increased by 40% and the fee on a “gold” rewards card rose by 30%, from A$98 to A$128.61F^[62]
• Between 2003 and 2011, the estimated benefit of rewards fell by one third, from $0.81 to $0.54 per dollar spent.59F^[63]

In addition, issuers introduced caps on the total number of rewards that could be earned in a given period.[64] This turns the conventional rewards-card model on its head: instead of creating incentives to use the rewards card more to achieve specific additional benefits, Australian credit-card issuers now provide incentives for rewards-card holders to switch cards when they reach the cap.

Shortly after Australia’s interchange-fee caps for four-party cards came into force in 2003, two banks introduced three-party credit cards with annual fees and rewards similar to those that previously existed on their four-party cards.72F^[65] In addition, several issuers introduced packages of two similar premium rewards cards, one that operates on a four-party network and one that operates on a three-party network.73F^[66] The reason these “companion cards” were created is that far fewer merchants accept three-party cards than four-party cards; with both cards, consumers could use the higher-earning three-party card where it is accepted and the lower-earning four-party card elsewhere.

Unsurprisingly, the market share of three-party cards, while still relatively small, increased considerably following the 2003 regulations. By volume of transactions, three-party cards increased from about 10% in 2002 to about 16% in 2013 (a 60% increase). By value of transactions, they increased their market share from about 15% in 2002 to more than 20% in 2013 (a 33% increase).

In October 2015, the RBA designated American Express Companion Cards a “payment system”74F^[67] and subsequently announced that, as of July 1, 2017, the cards would be subject to the same interchange-fee caps as other designated cards.75F^[68] Following the introduction of these caps, companion cards were discontinued and the market share by volume of three-party cards fell back to between 7% and 8% (but subsequently rose again slightly to about 8%).76F^[69] By value, three-party cards’ market share of transactions also fell steeply after mid-2017, but is now back to about 20%.^[70]

2.        Spain: Fewer rewards, higher interest rates, higher fees

In 2005, the Spanish government introduced gradually tightening price controls on interchange fees by “agreement” with the country’s banks. For credit cards, the controls started at 1.4% in 2006, falling to 0.79% in 2009-10. In response, local issuers reduced the rewards available from cards.57F^[71] Meanwhile, from 2008 to 2010, issuers increased interest rates on credit cards from an average of 3% above the European Central Bank (ECB) base rate in 2005 to 4.6% above base.58F^[72] As a result, income from interest payments was nearly 80% higher from 2006 to 2010 than in 2005, representing a total incremental increase in income from interest over the period of about €2.6 billion (although this could be an overstatement, since we are only comparing to revenue in 2005). At the same time, average annual fees on credit cards rose by 50%, from €22.94 to €34.39, generating incremental revenue over the period of €1.7 billion.

3.        EU: Fewer rewards, higher interest rates, and foreign transaction fees

In 2014, the European Union (EU) adopted the Interchange Fee Regulation (IFR), which imposed price controls on debit- and credit-card interchange fees at 0.2% and 0.3%, respectively, with the regulation taking effect Jan. 1, 2015. The IFR initially applied only to four-party cards (primarily to Visa and Mastercard, but also some domestic payment cards).

In response to the IFR, credit-card issuers significantly reduced rewards on credit cards, or terminated rewards cards altogether.[73] Several airlines have nonetheless continued to co-brand rewards cards. American Express cards were all initially excluded from the rules, so airlines that already had an Amex co-branded card (such as British Airways) were not affected. Following a decision by the European Court of Justice in 2018, however, the IFR was deemed to also apply to co-branded cards issued by three-party networks.

As in Australia, issuers in the EU increased annual fees on cards that already had fees.[74] The total revenue from annual fees fell, however, presumably because consumers switched to cards without fees (Table 2). Issuers nonetheless made up much of the revenue lost from the interchange price controls by increasing interest rates. As noted below, this enabled them to continue to offer rewards. As Table 2 shows, while revenue from interchange fees fell by nearly 50% between 2014 and 2018, issuer revenue related to credit cards fell by less than 5%.[75]

[76]

In addition, while rewards in the EU fell significantly across the board, some co-branded airline-rewards cards in the EU and the United Kingdom (which retained IFR caps on domestic transactions post-Brexit) earn at a rate that is nominally worth the equivalent of 1% to 1.5% of the amount spent on the card—that is, three to five times the interchange fee. For example, American Express (whose co-branded cards are now subject to the same fee caps as four-party cards) offers two British Airways co-branded cards in the UK, one that has an annual fee of £250 and earns 1.5 Avios per £1 on general spend, and 3 Avios per £1 spent on BA. The other card has no annual fee and earns 1 Avio per £1 spent. ^[77] Meanwhile, the value of each Avios is between 0.66 and 1.5p, depending on its use.[78]

There are several feasibly explanations for why the value of rewards exceeds the amount of interchange fees. First, issuers may be able to purchase airline-loyalty rewards at a significant discount. Because airlines know that they will be able to encourage holders to redeem them on flights that otherwise would not be full, the marginal cost is likely much lower than the nominal value. Second, other partner companies that redeem loyalty rewards may also be willing to do so at a discount, knowing that such redemptions both encourage loyalty to that partner and, in some cases, will only represent partial payment for goods and services, thereby acting effectively as a discount on larger purchases. Third, card issuers may be using other income—such as annual fees, interest, and late fees—to cover the shortfall. It is possible that all three explanations are true.

If card issuers in the EU are using additional revenue from higher-interest charges and late fees to cross-subsidize rewards cards—including airline co-branded rewards cards—then the IFR is effectively highly regressive. This is because late fees and interest charges are predominantly paid by individuals with lower credit scores and who spend less on their cards but keep a revolving balance, whereas rewards are earned primarily by people with higher credit scores who pay off their balance each month.

4.        US: Debit cards and the Durbin amendment

When the Federal Reserve adopted Regulation II, implementing the interchange-fee price controls required by the Durbin amendment to Dodd-Frank, some covered issuing banks initially responded by stating that they would introduce consumer fees for the use of debit cards.[79] That idea immediately met with backlash, so the banks instead increased monthly account fees and increased the minimum balance required for free checking, as documented by economists at the Federal Reserve.[80] Banks also essentially eliminated rewards for debit cards. Evidence suggests that the higher bank-account charges and higher minimum-balance requirement for free checking most likely led to a significant increase in the number of unbanked individuals. [81]

Meanwhile, the evidence also suggests that consumers received little, if anything, in return. A survey conducted by economists at the Federal Reserve Bank of Richmond two years after the implementation of Regulation II found that:

[T]he regulation has had limited and unequal impact on merchants’ debit acceptance costs. In the sample of 420 merchants across 26 sectors, two-thirds reported no change or did not know the change of debit costs post-regulation. One-fourth of the merchants, however, reported an increase of debit costs, especially for small-ticket transactions. Finally, less than 10 percent of merchants reported a decrease of debit costs. The impact varies substantially across different merchant sectors.

The survey results also show asymmetric merchant reactions to changing debit costs in terms of adjusting prices and debit restrictions. A sizable fraction of merchants are found to raise prices or debit restrictions as their costs of accepting debit cards increase. However, few merchants are found to reduce prices or debit restrictions as debit costs decrease.[82]

A subsequent study by economists Vladimir Mukharlyamov and Natasha Sarin investigated the Durbin amendment’s effects on consumers using a proprietary dataset of gasoline sales in different ZIP codes.[83] (Gas is a widely consumed commodity sold in a highly competitive market, and is thus arguably the product most likely to see interchange-fee savings passed through.) The researchers found that gas is, “cheaper in ZIP codes with a greater fraction of transactions paid with debit cards issued by large banks,” which suggests that at least some retailers passed on some savings. They note, however, that “the standard deviation of per-gallon gas prices ($0.252) is 168 times larger than the average per-gallon debit interchange savings ($0.0015). Relatedly, total Durbin savings for gas merchants amount to less than 0.07% of total sales. These points render the quantification of merchants’ pass-through with statistical significance.” In other words, whatever savings retailers passed on to consumers were tiny.

At the same time, using data from bank call reports and the Federal Deposit Insurance Corporation’s summary of deposits, Mukharlyamov and Sarin found that banks covered by the price controls “collectively lost $5.5 billion in annual revenue” from interchange fees. And using data from RateWatch, they found those banks “passed 42 percent of these losses through to their customers.”[84] Specifically:

We estimate that the share of free checking accounts fell from 61 percent to 28 percent as a result of Durbin. Average checking account fees rose from $3.07 per month to $5.92 per month. Monthly minimums to avoid these fees rose by 21 percent, and monthly fees on interest-bearing checking accounts also rose by nearly 14 percent. These higher fees are disproportionately borne by low-income consumers whose account balances do not meet the monthly minimum required for fee waiver.[85]

So, while the Durbin amendment served to dramatically reduce interchange fees on debit transactions, the main effect was to increase bank fees for poorer consumers, causing some of them to leave the banking system altogether and likely become reliant on more expensive forms of credit, such as payday loans.

B.      Routing Regulations

The only jurisdiction to have thus far implemented regulations mandating “competition” in network routing is the United States, which included such a mandate for debit cards in the Durbin amendment. Some other jurisdictions, most notably Australia, have contemplated such regulations. But in its most recent report on the matter, the RBA rejected mandatory “least cost routing.”[86] This subsection thus focuses on the effects of the Durbin amendment’s routing requirements.

1.        The Durbin amendment routing requirements

In addition to interchange-fee price controls on “covered” issuers—i.e., banks with assets of at least $10 billion—the Durbin amendment required the Federal Reserve Board to impose routing requirements on the debit transactions of all banks. Specifically, it mandated that these regulations should prohibit issuers and payment networks from imposing network-exclusivity arrangements.[87] In particular, all issuers must ensure that debit-card payments can be routed over at least two unaffiliated networks. It also required the Federal Reserve Board to prohibit issuers and payment networks from restricting merchants and acquirers’ ability to choose the network over which to route a payment.

[88]

As Figure 2 shows, for covered issuers, average interchange fees per-transaction fell to the regulated maximum for both dual-message (signature) transactions and single-message (PIN) transactions immediately following implementation of the Durbin amendment in October 2011. Meanwhile, discounting for inflation, average fees per-transaction for issuers that were exempted from the price controls fell by only about 10% for dual-message transactions, which were not subject to direct competition for routing. For single-message transactions, however, routing was subject increasingly to direct competition, and average fees per-transaction for exempt issuers fell by 30% over the course of eight years; by 2019, fees were only marginally higher than the regulated maximum for covered issuers.

Based on the experience of mandatory routing under the Durbin amendment, then, it seems highly likely that the CCCA would, if implemented, drive down the price of interchange, as proponents want. And issuers would respond as they did to the Durbin amendment, by finding other ways to recoup lost revenue. Consumers would again almost certainly endure the most of this shift through higher card fees, higher interest rates, and fewer benefits, including less generous rewards.

V.      How Would the CCCA Affect Co-Branded Credit Cards?

This section draws on the discussion in Section IV to infer the potential effects the CCCA would likely have on co-branded credit cards. It begins with a discussion of the effect on issuer revenue in general. It then looks at how issuers might address the loss of revenue through, e.g., increases in annual card fees, increases in interest rates and late payment fees, reduction in rewards, reduction in other benefits, and the introduction of “companion cards.” This is followed by a discussion of the potential effect on airlines.

A.      Effect on Issuer Revenue

As noted, the stated intention of the CCCA is to reduce merchants’ costs by lowering interchange-fee revenue. One proponent of the CCCA has claimed that it “could result in annual savings upward of $15 billion.”[89] But this claim is not supported by any evidence; indeed, so far as this author can tell, it seems to have been plucked out of thin air.

While it is likely that interchange-fee revenue will be reduced, it is difficult to know with any degree of precision by how much, or what other effects might occur. (As to the effect on merchant costs—that is quite another matter, as will be discussed later.) Much will depend on which networks issuers include as the secondary networks on their cards. This, in turn, will likely depend on complex negotiations among the issuers, the primary networks, and the various possible secondary networks. Factors that will affect the decision regarding which network is included as a secondary network on a card are likely to include:

• The extent to which the secondary network is able to meet fraud and other security concerns of the issuer. For example, many of the alternative networks were designed to operate with ATMs, and are thus PIN-based single-message systems that do not offer dual-message transmission. Since at least some proportion of transactions on any credit card are likely to require dual-message transmission for the purposes of meeting such EMVCo standards as 3DS (in part, to limit the potential for card-not-present fraud), it is unclear how a single-message (PIN) network could be the secondary network.
• Issues related to brand reputation of the two networks. This could affect, for example, the willingness of three-party networks to function as secondary networks, because those networks have positioned themselves as premium brands. Meanwhile, similar to the issuer concerns, Visa and Mastercard would be understandably reluctant to have a network with poor security and fraud detection as a secondary network on cards bearing their brands.
• Relatedly, three-party networks might be reluctant to function as secondary networks if they expect that participation would result in a reduction in the rates they could charge merchants on their own closed-loop network.
• Whether issuers wish to and are able to issue “companion cards” by partnering with three-party networks as the sole network, as Australian banks did for a while (see Subsection B below), which might also affect three-party cards’ incentives to function as secondary networks.
• Which networks might be prohibited under Article D of the CCCA, which prohibits secondary networks that are either a national security risk or are “owned, operated, or sponsored by a foreign state entity.”[90] This would seem to eliminate China Union Pay, whose member banks are primarily state-owned. And potentially, it could be applied to any network, as “national security risk” is not well-defined.

These factors generally militate against single-message networks, three-party networks, and China Union Pay becoming secondary networks on credit cards. As such, many covered issuers might plausibly choose JCB Co. Ltd. (formerly Japan Credit Bureau) as their secondary network, assuming that JCB is not deemed to be a national security risk. JCB is a member of EMVCo and applies the same basic security standards as other EMVCo companies (Visa, Mastercard, American Express, Discover, and China Union Pay).[91] Unlike China Union Pay, however, JCB is a private enterprise, and so should not fall afoul of Article D of the CCCA. JCB has an agreement with Discover that enables JCB cardholders to use their cards in the United States by running them over the Discover network. By adding JCB as the secondary network, issuers would therefore effectively utilize Discover’s network, including the application of EMVCo rules, such as 3DS, which provides enhanced fraud protection for card-not-present transactions.[92]

Since the JCB secondary network would actually be run over the Discover network, the interchange rates that would be applied would presumably be Discover’s, which are similar on average to those of Visa and Mastercard, but appear to be slightly higher for standard cards and slightly lower for the higher-end rewards-type cards.[93] Assuming cards are programmed to apply interchange rates for somewhat equivalent products, the initial effect of the CCCA on interchange-fee revenue could, in theory, be modest.

That sounds like good news. Over the medium to longer term, however, this artificial “competition” between the networks on the card would almost inevitably lead to a gradual reduction in fees, as each network seeks to attract more users in each category. This is precisely what happened with PIN debit networks for banks and credit unions that were exempted from the Durbin amendment’s price controls on interchange fees. This would continue until each network could barely cover its costs in each category. In that case, the effect on interchange-fee revenue could be devastating.

The analogy here is not to the dynamic competition that drives innovation in conventional markets, guided by a process of price discovery that seeks to provide consumers with better goods and lower prices through the development of more efficient processes that consume fewer resources. The analogy here is, rather, the “tragedy of the commons,” or more precisely, the tragedy of open access. In effect, by forcing networks to compete on price alone—maximizing use, while minimizing expenditure on improvements—the result will be diminution in network quality, just as when anglers chase after fish stocks until they are economically exhausted (too depleted to be worth chasing).[94]

We can push the overfishing analogy further. Initially, fishers often do not notice that they are depleting the stock, but over time, they have to increase the amount of effort they put into fishing until the returns no longer justify the investment. A similar thing could happen with payment networks, with the effects initially being muted by decades of investment in security protocols and the collection of transaction data. But over time, the value of those investments and data will wither.

The solution to the open-access problem has been well-known to economists for more than half a century: establish clearly defined and readily enforceable property rights.[95] This has proved challenging in fisheries, but an increasing number of jurisdictions have developed successful approaches of various kinds.[96]

The irony is that the networks have expressly sought to avoid this tragedy by developing clear rules regarding who has access to the data transmitted from their cards, how it is transmitted, to whom, and under what conditions.

Interchange fees, as they exist today, are one of those rules: they are the default in open-network schemes and exist, at least in part, because of the high costs of negotiating and enforcing many bilateral agreements among banks.^[97] They are set by payment-network operators, who are able to avoid the problems that would arise if individual issuing banks set their own fees. The latter might lead to fees being set at inefficiently high levels in order to maximize issuing-bank revenue, without regard to the impact on the value of the system as a whole.21F^[98]

The CCCA would run roughshod over those rules.

B.      Response by Issuers to Compensate for Revenue Losses

Proponents of the CCCA seem to assume that issuers will simply accept the loss of revenue from interchange fees and do nothing to try to compensate. Based on the experience of both the Durbin amendment and of interchange regulations in other jurisdictions, this is an incorrect assumption.

In practice, it seems almost certain that card issuers would implement one or more of several measures to recover the lost revenue and/or reduce costs. Among other things, they might:

• Increase annual card fees. In Australia, banks increased annual card fees by 30% to 40%. In Europe, they increased them by about 13%.[99] Such fees tend to be regressive, because they are charged at a fixed rate regardless of how much a cardholder spends. Thus, for lower-income cardholders who spend less, such a fee increase would be proportionately more onerous.
• Remove insurance and other benefits. Many U.S. credit cards currently offer cardholders a range of benefits, often including purchase-protection insurance, car-rental insurance, travel insurance, and fee-free international transactions. These benefits were also common on cards issued in the EU prior to the introduction of the IFR, but were removed afterwards. As a result, most cards—including rewards cards—now have limited, if any, insurance and charge a transaction fee of between 2% and 3% for international transactions.
• Increase late-payment fees (if not prohibited from so doing by other regulations) and interest rates. In the EU, issuers increased late-payment fees and interest rates following the introduction of the IFR. Between 2014 and 2016, interest rates on revolving balances rose from an average of 16.2% to 18.8%, while the European Central Bank base rate fell from 0.3% to 0.25%. This implies an increase in average real rates on credit cards of 2.75%. Likewise, in Spain, credit-card interest rates were increased at a substantially faster rate than increases in rates at the European Central Bank, with the result that revenue from interest rose by 80% during the period when IFRs were subject to national price controls on interchange fees, from 2006 to 2010.

The determination of which fees to increase and by how much will depend on issuers’ views regarding the willingness of cardholders to bear such fees. Likewise, the determination of which benefits to withdraw on which cards will be made—possibly simultaneously with the determination of any increase in annual fees (which could be used to cover such benefits in whole or in part)—on the basis of the effects such changes will have on demand for cards.

1.        Responses by issuers of co-branded rewards cards

As noted earlier, issuers typically cover the costs of rewards on co-branded cards through some combination of annual fees and interchange fees. Issuers also often pay for other items, ranging from lounge access for cardholders to marketing fees for promoting the card and related services, the costs of which also must be paid for by some combination of merchants and users.

Since the costs associated with co-branded rewards cards are typically higher than the costs of other non-rewards cards, the effects of the CCCA would likely be much more severe for such co-branded cards. As such, issuers of co-branded cards may seek to implement additional measures in order to recover revenue and ensure that they meet their obligations to cardholders and co-brand partners.

2.        Responses by issuers of airline-rewards co-branded cards

As noted, in the UK and some EU jurisdictions, issuers have continued to co-brand credit cards with airlines. Moreover, while rewards have been reduced significantly, and many other card benefits—such as insurance and fee-free foreign transactions—have largely been eliminated, the amount earned in rewards per euro or pound spent remains notionally higher than the interchange fee on the card. As also noted, there are several possible explanations for this, including that airlines may sell rewards at a discount, or that issuers were able to make up some of the losses on interchange fees by increasing interest rates, late fees, and foreign transaction fees. If the CCCA were enacted, we might see issuers adopt some combination of these approaches.[100]

In Australia, issuers put caps on the amounts of rewards that could be earned. As noted, this effectively inverts the purpose of such rewards, which are intended to engender loyalty, but if the amount that can be earned is capped or the earning rate declines after a certain spend, then users will have incentives at that point to switch to a different card. While this would reduce the loyalty element of the co-branded card (perversely encouraging disloyalty, in fact), U.S. issuers of multiple co-branded cards might be motivated to pursue this approach in order to drive short-term spending on each of their cards, especially if they have agreements to purchase a certain number or rewards at a discounted price.

C.      The Effect on Airlines and Their Response

The effect of the CCCA on airlines will depend very much on which networks become secondary networks, whether issuers are able to issue companion cards, and all the other factors discussed above. But in almost any imaginable scenario, the airlines that currently co-brand four-party credit cards will see a reduction in revenue. In many scenarios, that revenue reduction could be significant—in some cases it could be 5% to 10% of total revenue. While this would be partly offset by a reduction in liability associated with outstanding loyalty-rewards points, there is a timing mismatch effect: The revenue loss will occur in the short term, while the rewards-redemption effect occurs over a longer time horizon.

In addition, to the extent that airlines are unable either to offer companion cards or switch altogether to three-party cards—and thereby offer their loyal customers continued benefits at a similar level to those available on their current cards—there will almost certainly be some attrition of loyalty. In other words, some proportion of fliers who are currently loyal to American, United, Southwest, JetBlue, Alaska, and other smaller airlines with four-party co-branded credit cards will switch to Delta. Moreover, the evidence suggests that those most likely to switch will be those most adversely affected by the change—that is to say, those who tend to spend the most on their co-branded rewards card.

This likely includes many middle-class consumers who live far away from family members and currently value the rewards from their co-branded card highly. To the extent that those individuals are also among the most loyal to the airlines whose co-branded cards they use, this could have a seriously detrimental effect on the profit margins of the other airlines.

The CCCA may also affect many airlines’ costs of capital. For example, at least for United and American Airlines, a reduction in expected revenue from the sale of rewards could result in the downgrading of the bonds issued during the COVID-19 pandemic by the subsidiaries that now own the rewards programs. That could trigger covenants requiring the parent companies to post additional capital, which in turn would increase the parents’ capital costs. In general, the combination of reduced revenue and reduced membership of loyalty programs—leading to lower revenue from higher-value customers—would reduce airlines’ expected future profitability, which would increase capital costs. In times when demand for air travel is high, this may not pose a dramatic problem. It would, however, likely affect fleet investment, which would adversely affect the flying experience and might lead to the termination of some routes. And in a downturn, it could result in the bankruptcy that the airlines previously avoided, thanks to their ability to securitize their loyalty programs.

VI.    Conclusions

This study has focused relatively narrowly on the likely effects of the CCCA on co-branded reward credit cards and the knock-on effects on the co-brand partners, especially airlines. If enacted, however, the law’s effects would be far broader. For example, it would likely cause a reduction in investment in innovation by card issuers and networks for at least two reasons. First, by reducing prospective revenue, the CCCA would reduce network providers’ incentive and ability to invest in innovation. Second, by requiring networks to make tokens interoperable, the CCCA dramatically reduces the incentive to invest in improvements to the security, convenience, and other aspects of tokenized transactions.

Proponents of the Credit Card Competition Act (CCCA) claim that it would “enhance credit card competition and choice in order to reduce excessive credit card fees.” In fact, by forcing the majority of credit-card issuers in the United States to include a second network on all their cards, the CCCA would remove the choice of network from the issuer and cardholder and place it in the hands of the merchant and the acquiring bank.

Indeed, the name of the Credit Card Competition Act would appear to be unintentionally ironic, since one of its main effects would be to reduce competition between issuers, as margins would be reduced, and issuers would be less able to differentiate on the basis of such offerings as co-branded cards (airlines, hotels, retailers). As a result, there would be less pressure to compete on interest rates, which in turn would mean that—as happened in the EU and especially in Spain—issuers would likely increase interest rates in order to offset reduced interchange-fee revenue.

To the extent that issuers use this offsetting revenue from interest to enable them to continue to offer some level of rewards, the CCCA would have brought about what some critics of credit-card rewards have previously falsely accused issuers of doing: using credit cards to transfer wealth from lower-income, lower-spending consumers who maintain a revolving balance to higher-income, higher-spending consumers who pay off their balances every month.[101]

Even if issuers do continue to offer rewards, the evidence from Europe and Australia is that the CCCA would cause such rewards to be diminished significantly, harming consumers both directly and indirectly. The direct harms would come in the form of fewer rewards (except for those consumers who only use three-party cards). The indirect harms would come through the effects on businesses that currently rely heavily on revenue from co-branded cards that would be diminished by the CCCA.

As this study has demonstrated, airlines, in particular, could be adversely affected, leading to reduced fleet investment, termination of routes, and potentially to bankruptcy. There would also likely be a broader adverse effect, as consumers reduce their use of credit cards (including some who give them up), which would result in an overall reduction in consumption—harming both merchants and the broader economy.

Appendix: Routing in Payment Networks

When a cardholder submits a transaction for payment, information regarding that payment is sent over a proprietary network. This is called “routing.” There are, broadly, two types of payment network: single-message (PIN) networks that emerged from ATM networks, and dual-message (signature) networks that were developed by the credit-card networks (Visa, Mastercard, American Express, and Discover). In general, credit cards require dual-message networks, whereas debit transactions can run over either type of network. To understand why, it is worth briefly explaining the mechanics of the two systems.

• Single-message (PIN) debit networks

Single-message networks rely on the PIN stored in the card to authenticate a transaction. As a result, the only message that is required is a notification to the issuing bank to debit the account of the cardholder in the amount they have authorized, and to credit that amount the account of the merchant—less the discount fee, which is paid to the acquiring bank. Because of the nature of the transaction, settlement can be effected over banks’ electronic-funds-transfer (EFT) networks that were initially built to settle transactions at shared ATMs, and then over networks of ATMs.^[102]

• Dual-message (signature) networks

As the name suggests, dual-message networks send two messages: the first is a request for authorization sent to the issuing bank, which confirms the authenticity of the card, checks whether the cardholder has sufficient credit available, and monitors for fraud. If authorized, the second message contains information confirming the amount to be credited to the merchant’s account during clearing and settlement.

For example, if you present your credit card at a sit-down restaurant, the check total would be authorized by the network and a “hold” or “pending transaction” amount would appear on your account. The opportunity to add a tip to the bill permits a second, later message that authorizes payment of the full amount of food, plus a tip to be credited to the merchant. Similar “holds” are also often used by online merchants in order to delay payment (sometimes by as much as several days), thereby reducing the likelihood of fraud and associated chargebacks.^[103]

[1] See Developments in Noncash Payments for 2019 and 2020: Findings From the Federal Reserve Payments Study, Federal Reserve Board, (Dec. 2021), available at https://www.federalreserve.gov/publications/files/developments-in-noncash-payments-for-2019-and-2020-20211222.pdf, along with the various previous studies and associated data, https://www.federalreserve.gov/paymentsystems/frps_previous.htm.

[2] See, e.g., Mastercard Rules, Mastercard, https://www.mastercard.us/en-us/business/overview/support/rules.html (last accessed Nov. 16, 2023); Visa Rules and Policy, Visa, https://usa.visa.com/support/consumer/visa-rules.html (last accessed Nov. 16, 2023).

[3] 156 Cong. Rec. S3,571 (daily ed. May 12, 2010), available at https://www.congress.gov/111/crec/2010/05/12/CREC-2010-05-12-pt1-PgS3569-9.pdf.

[4] Claire Tsosie, The History of the Credit Card, NerdWallet.com (Mar. 15, 2021), https://www.nerdwallet.com/article/credit-cards/history-credit-card; see also Jeremy Norman, The Charga-Plate, Precursor of the Credit Card, Circa 1935 to 1950, HistoryofInformation.com, https://www.historyofinformation.com/detail.php?id=1710 (last accessed Nov. 16, 2023).

[5] See Todd J. Zywicki, The Economics of Payment Card Interchange Fees and the Limits of Regulation, International Center for Law & Economics (Jun. 2, 2010), available at http://laweconcenter.org/images/articles/zywicki_interchange.pdf. Several banks also attempted to establish three-party cards during the 1950s. Most of these were unsuccessful. The exception was Bank Americard, which subsequently became a four-party system and eventually rebranded as Visa.

[6] The issuer may arrange separate underwriting. More recently, the processing of three-party card transactions are sub-contracted to other payment processors, but the fundamental three-party legal arrangements remain the same.

[7] For a more detailed explanation of the operation of payment-card systems, see Zywicki, supra note 5, at 27-30.

[8] See Zywicki, supra note 5; see also Jean-Charles Rochet & Jean Tirole, Two-Sided Markets: A Progress Report, 37 Rand J. Econ. 645 (2006); As the U.S. Supreme Court wrote in Ohio v. American Express Co. (585 U.S. Slip Op, 2018, at 2): By providing these services to cardholders and merchants, credit-card companies bring these parties together, and therefore operate what economists call a “two-sided platform.” As the name implies, a two-sided platform offers different products or services to two different groups who both depend on the platform to intermediate between them.”… For credit cards, that interaction is a transaction…. 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.

[9] Bruno Jullien, Alessandro Pavan, & Marc Rysman, Two-Sided Markets, Pricing, and Network Effects, in Handbook of Industrial Organization (Vol. 4), 485-592, (2021).

[10] Thomas Eisenmann, Geoffrey Parker, & Marshall W. Van Alstyne, Strategies for Two-Sided Markets, Harv. Bus. Rev. (Oct. 2006).

[11] Ohio v. American Express Co. (585 U.S. Slip Op, 2018), at 13.

[12] Zywicki, supra note 5, at 10.

[13] Tsosie, supra note 4.

[14] Visa USA Interchange Reimbursement Fees, Visa Public (Apr. 23, 2022), available at https://usa.visa.com/content/dam/VCOM/download/merchants/visa-usa-interchange-reimbursement-fees.pdf; Mastercard USA Interchange Rates, HELCIM, https://www.helcim.com/mastercard-usa-interchange-rates (last accessed Nov. 16, 2023).  

[15] Jean-Charles Rochet & Jean Tirole, An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems, 2 Rev. Netw. Econ. 69-79 (Jan. 2003).

[16] See Todd J. Zywicki, The Economics of Payment Card Interchange Fees and the Limits of Regulation, International Center for Law & Economics (Jun. 2, 2010), available at http://laweconcenter.org/images/articles/zywicki_interchange.pdf; Todd J. Zywicki, Geoffrey A. Manne, & Julian Morris, Unreasonable and Disproportionate: How the Durbin Amendment Harms Poorer Americans and Small Businesses, International Center for Law & Economics (Apr. 25, 2017); Todd J. Zywicki, Geoffrey A. Manne, & Julian Morris, Price Controls on Payment Card Interchange Fees: The U.S. Experience, George Mason Law & Economics Research Paper No. 14-18, (Jun. 6, 2014).

[17] Credit Card Competition Act of 2023, S. 1838, 118th Cong. § 1 (2023).

[18] James J. Nagle, Trading Stamps: A Long History, The New York Times (Dec. 26, 1971), https://www.nytimes.com/1971/12/26/archives/trading-stamps-a-long-history-premiums-said-to-date-back-in-us-to.html

[19] Michael McCall & Clay Voorhees, The Drivers of Loyalty Program Success, 51 Cornell Hosp. Q. 35 (2010).

[20] This seems to have been an essential part of the business model of trading-stamp programs.

[21] Evert R. de Boera & Sveinn Vidar Gudmundsson, 30 Years of Frequent Flyer Programs, 24 J. Air Transp. Manag. 18-24 (2012).

[22] Id. at 19.

[23] Enny Kristiani, Ujang Sumarwan, Lilik Noor Yulianti, & Asep Saefuddin, Customer Loyalty and Profitability: Empirical Evidence of Frequent Flyer Program, 5 J. Mark. Stud. 62 (2013).

[24] Abigail Ng, Over 40 Airlines Have Failed So Far This Year — And More Are Set to Come, CNBC (Oct. 8, 2020), https://www.cnbc.com/2020/10/08/over-40-airlines-have-failed-in-2020-so-far-and-more-are-set-to-come.html.

[25] For example, on June 30, 2020, American Airlines issued $2.5 billion of bonds dated 2025 with a coupon of 11.75%. American Airlines Inc. Dl-Nts 2020(20/25) Reg. S, Markets Insider,  https://markets.businessinsider.com/bonds/american_airlines_incdl-nts_202020-25_regs-bond-2025-usu02413ae95.

[26] Tracy Rucinski, United Airlines Pledges Loyalty Program for $5 Billion Loan, Reuters (Jun 15, 2020), https://www.reuters.com/article/us-health-coronavirus-united-arlns-idUSKBN23M1PB

[27] So Yeon Chun & Evert de Boer, How Loyalty Programs Are Saving Airlines, Harvard Business Review (Apr. 2, 2021), https://hbr.org/2021/04/how-loyalty-programs-are-saving-airlines.

[28] Cameron Graham, Study: Why Customers Participate in Loyalty Programs, TechnologyAdvice.com (Jul. 23, 2014), http://technologyadvice.com/blog/marketing/why-customers-participate-loyalty-programs.

[29] Michelle Geraghty & Trisha Asgierson, Relationship Rewards: A Game Changer for Financial Institutions, Mastercard (2013), available at https://www.mastercard.us/content/dam/mccom/en-us/documents/relationship-rewards-whitepaper.pdf.

[30] See, e.g., Blake Ellis, The Banks’ Billion-Dollar Idea, CNN Money (Jul. 8, 2011), http://money.cnn.com/2011/07/06/pf/banks_sell_shopping_data/index.htm.

[31] Marie-Pierre Lemay & Negar Ballard, Majority Say Credit Card Rewards Are Very Important, and Drive Their Card Usage, Ipsos (Jan. 12, 2021), https://www.ipsos.com/en-us/majority-say-credit-card-rewards-are-very-important-and-drive-their-card-usage.

[32] John S Kiernan, 2023 Credit Card Rewards Survey, WalletHub (Jun. 13, 2023), https://wallethub.com/blog/credit-cards-rewards-survey/63067.

[33] Id.

[34] American Airlines, AAdvantage Investor Presentation March 2021, SEC Form 8-K (Mar. 8, 2021), https://americanairlines.gcs-web.com/node/38926/html, at 26.

[35] “Loyalty revenue” covers various terms used by the airlines in their 10K filings to refer to income related to the generation of loyalty, including co-branded reward cards.

[36] De Boera & Gudmundsson, supra note 21, at 22.

[37] American Airlines, supra note 35, at 37.

[38] Since most of American Airline’s primary loyalty-rewards partners are also travel-related, it seems reasonable to assume that the vast majority of partner income in 2020 was from co-branded cards.

[39] See, infra Section II.B.

[40] The first such card was an American Airlines co-branded card issued by Citibank (De Boera & Gudmundsson, supra note 21, at 19).

[41] American Airlines, 10K Filing (2022), at p. 68.

[42] United Airlines, 10K Filing (2022), at p. 41.

[43] Delta Airlines, 10K Filing (2022), at p. 37.

[44] Southwest Airlines, 10K Filing (2022), at p. 115

[45] Id at 119.

[46] Id.

[47] Jay Sorensen, Frequent Flier Credit Cards Generate More than $4 Billion for Major U.S. Airlines, Ideaworks (2008), available at https://www.ideaworkscompany.com/wp-content/uploads/2012/05/Analysis_USAirlineCC2008.pdf. See also above discussion of revenue from loyalty-rewards programs during the COVID-19 pandemic.

[48] Technically, it prohibits issuers from restricting “the number of payment card networks on which an electronic credit transaction may be processed.”

[49] See S. 1838, §2(a)(2)(A)(II): 2 or more such networks, if— (aa) each such network is owned, controlled, or otherwise operated by— (AA) affiliated persons; or (BB) networks affiliated with such issuer; or (bb) any such network is identified on the list established and updated under subparagraph (D). Subparagraph (D) empowers the Federal Reserve Board, in consultation with the secretary of the U.S. Treasury, to draw up a list of networks that pose a national security risk.

[50] See S. 1838, §2(a)(2)(A)(III): the 2 such networks that hold the 2 largest market shares with respect to the number of credit cards issued in the United States by licensed members of such networks (and enabled to be processed through such networks), as determined by the Board on the date on which the Board prescribes the regulations.

[51] S. 1838, §2(a)(2)(B).

[52] Poonkulali Thangavelu, Credit Card Market Share Statistics, Bankrate.com (Jul. 6, 2023), https://www.bankrate.com/finance/credit-cards/credit-card-market-share-statistics.

[53] S. 1838, §2(a)(2)(A)(III).

[54] S. 1838, §2(a)(2)(C).

[55] Julian Morris & Todd J. Zywicki, Regulating Routing in Payment Networks, International Center for Law & Economics, (Aug. 17, 2022), available at https://laweconcenter.org/wp-content/uploads/2022/08/Regulating-Routing-in-Payment-Networks-final.pdf.

[56] Id.

[57] American Airlines, 10-K Filing (2022), at 39.

[58] For a discussion of these, see Julian Morris, Todd J. Zywicki, & Geoffrey A. Manne, The Effects of Price Controls on Payment-Card Interchange Fees: A Review and Update, International Center For Law & Economics (Mar. 4, 2022).

[59] The multilateral “interchange fee” was developed to address circumstances where the credit-card-issuing bank was different from the merchant-acquiring bank; otherwise, it was considered an “on us” transaction. Since all three-party-card network transactions are “on us” by definition, there is no need for an interchange fee.

[60] Morris, Zywicki, & Manne, supra note 58.

[61] Reform of Credit Card Schemes in Australia: IV Final Reforms And Regulation Impact Statement, Reserve Bank Of Australia (Aug. 2002), at 13.

[62] Emily Perry & Christian Maruthiah, Banking Fees in Australia, Reserve Bank of Australia Bulletin, (Jun. 2018), available at https://www.rba.gov.au/publications/bulletin/2018/jun/pdf/banking-fees-in-australia.pdf, at 5.

[63] Iris Chan, Sophia Chong, & Stephen Mitchell, The Personal Credit Card Market in Australia: Pricing Over the Past Decade, Reserve Bank of Australia Bulletin, (Mar. 2012), available at https://www.rba.gov.au/publications/bulletin/2012/mar/pdf/bu-0312-7.pdf.

[64] See Robert Stillman, William Bishop, Kyla Malcolm, & Nicole Hildebrandt, Regulatory Intervention in the Payment Card Industry by the Reserve Bank of Australia: Analysis of the Evidence, CRA International (2008), at 16.

[65] Chan, et al., supra note 63.

[66] Companion Cards Increase Credit Card Rewards, Mozo, (Dec. 8, 2009).

[67] Designation Under the Payment Systems (Regulation) Act 1998, Designation No 1 of 2015, Reserve Bank of Australia, (Oct. 18, 2015), available at https://www.rba.gov.au/media-releases/2015/pdf/mr-15-19-designation-2015-01-american-express-companion-card.pdf.

[68] Standard No. 1 of 2016, The Setting of Interchange Fees in the Designated Credit Card Schemes and Net Payments to Issuers, Reserve Bank of Australia (May 26, 2016), amended version available at https://www.rba.gov.au/payments-and-infrastructure/review-of-card-payments-regulation/pdf/standard-no-1-of-2016-credit-card-interchange-2018-05-31.pdf.

[69] C1.3: Market Shares of Credit and Charge Card Schemes, Reserve Bank of Australia, (Sep. 2023), https://www.rba.gov.au/statistics/tables/xls/c01-3-hist.xlsx.

[70] Id.

[71] Juan Iranzo, Pascual Fernández, Gustavo Matías, & Manuel Delgado, The Effects of the Mandatory Decrease of Interchange Fees in Spain, Munich Personal Repec Archive, MPRA Paper No. 43097, (Oct. 2012), available at https://mpra.ub.uni-muenchen.de/43097/1/MPRA_%20paper_43097.pdf. at 34-37.

[72] Id. at 27. See also marginal lending-facility rates from the European Central Bank, https://sdw.ecb.europa.eu/browse.do?node=9691107.

[73] Interchange: Card Rewards Cull Takes Hold Across Europe, Loyalty Magazine (Dec. 11, 2015) https://www.loyaltymagazine.com/interchange-card-rewards-cull-takes-hold-across-europe.

[74] Interchange Fee Regulation Impact Assessment Study, Edgar Dunn & Co. (2020), at 22 (noting that, for their sample of cards with fees, annual fees rose by an average of 13% between 2014 and 2018).

[75] Table 2 does not explicitly account for inflation, but cumulative inflation from 2014 to 2018 was 1.75%. European Union Inflation Rate 1960-2023, Macrotrends (2023), https://www.macrotrends.net/countries/EUU/european-union/inflation-rate-cpi.

[76] Edgar Dunn, supra note 74, at 23.

[77] British Airways American Express® Premium Plus Card, American Express, https://www.americanexpress.com/en-gb/credit-cards/ba-premium-plus-credit-card/?linknav=en-gb-amex-cardshop-BritAirwaysAmexCC-details-learnmore-BritAirwaysPremiumPlusCC-rc (last accessed Nov. 16, 2023).

[78] Rob Burgess, What Is the Best Use of American Express Points?, Head for Points (Oct. 7, 2023), https://www.headforpoints.com/2023/10/07/what-is-the-best-use-of-american-express-points-4.

[79] See, e.g., Tara Siegel Bernard, In Retreat, Bank of America Cancels Debit Card Fee, The New York Times (Nov. 1, 2011), http://www.nytimes.com/2011/11/02/business/bank-of-america-drops-plan-for- debit-card-fee.html.

[80] Mark D. Manuszak & Krzysztof Wozniak, The Impact of Price Controls in Two-sided Markets: Evidence from US Debit Card Interchange Fee Regulation, Federal Reserve Board (Jul. 2017), https://doi.org/10.17016/FEDS.2017.074.

[81] Todd J. Zywicki, Geoffrey A. Manne, & Julian Morris, Unreasonable and Disproportionate: How the Durbin Amendment Harms Poorer Americans and Small Businesses, International Center for Law & Economics (Apr. 25, 2017), available at http://laweconcenter.org/images/articles/icle-durbin_update_2017_final.pdf; Morris, Zywicki, & Manne, supra note 58.

[82] Zhu Wang, Scarlett Schwartz, & Neil Mitchell, The Impact of the Durbin Amendment on Merchants: A Survey Study, 100(3) Economic Quarterly 183-208 (2014), at 189.

[83] Vladimir Mukharlyamov & Natasha Sarin, Price Regulation in Two-Sided Markets: Empirical Evidence from Debit Cards, Working Paper (2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3328579.

[84] Id. at 3.

[85] Id. at 3.

[86] Review of Retail Payments Regulation: Conclusions Paper, Reserve Bank of Australia (Oct. 2021), https://www.rba.gov.au/payments-and-infrastructure/review-of-retail-payments-regulation/conclusions-paper-202110/index.html.

[87] 15 U.S. Code §1693o–2(b).

[88] Regulation II (Debit Card Interchange Fees and Routing), Fed. Rsrv., https://www.federalreserve.gov/paymentsystems/regii-data-collections.htm; Consumer Price Index: All Items for the United States, Fed. Rsrv. Board of St. Louis, https://fred.stlouisfed.org/series/USACPIALLMINMEI (last accessed Aug. 10, 2022).

[89] Martha Southall, Credit Card Competition Act Could Result in Annual Savings Upward of $15 Billion, CMPSI (Jun. 7, 2023), https://cmspi.com/credit-card-competition-act-could-result-in-annual-savings-upward-of-15-billion. (CMPSI describes itself as “the go-to advisory firm for leading merchants across the globe, looking to supercharge their payments arrangements.”)

[90] S. 1838, §2(a)(2)(D)(II).

[91] Overview of EMVCo, EMVCo.com, https://www.emvco.com/about-us/overview-of-emvco (last accessed Nov. 16, 2023).

[92] For an explanation, see Morris & Zywicki, supra note 55.

[93] Anna G., Interchange Rates, CreditDonkey (Jun. 2, 2023), https://www.creditdonkey.com/interchange-rates.html. Note that these are only selections of all the available rates.

[94] H Scott Gordon, The Economic Theory of a Common-Property Resource: The Fishery, 62 J Political Econ 124 (1954).

[95] Anthony Scott, The Fishery: The Objectives of Sole Ownership, 63(2) J Political Econ Journal of Political Economy 116-124 (Apr. 1955).

[96] See, e.g., Christopher Costello, Introduction to the Symposium on Rights-Based Fisheries Management, 6(2) Rev Environ Econ Policy 212-216 (2012), and related articles.

[97] Eliana Garcés & Brent Lutes, Regulatory Intervention in Card Payment Systems: An Analysis of Regulatory Goals and Impact, working paper, (Sep. 21, 2018), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3346472, at 8. As Garces and Lutes note: Practically all open network schemes have set some default interchange fees that apply automatically when no bilateral agreement exists between banks. No widely adopted international scheme relies solely on bilateral negotiations for the interchange fee. This may be due to the excessive level of information complexity that a system of bilaterally negotiated fees would imply for merchants. To assess the cost of a card payment, the merchant would have to know not only the brand and type of the card used, but also the identity of the issuer. Additionally, given that most card systems impose an “honor all cards” rule on merchants, the absence of a common interchange fee may lead some issuing banks to impose high interchange fees for the cards that they issue and that the merchant is forced to accept. Although there are open network schemes that have operated without interchange fees, these are very rare and with limited regional scope.

[98] William F. Baxter, Bank Interchange of Transactional Paper: Legal and Economic Perspectives, 26 J. L. & Econ. 541 (1983), at 572-582.

[99] Edgar Dunn & Co., supra note 74 at 22.

[100] The CFPB is currently considering imposing price controls on late fees. If it were to do that, then issuers would likely compensate in other ways, such as through higher interest rates. Issuers would also likely deny credit cards to individuals with lower credit scores.

[101] Morris & Zywicki, supra note 55.

[102] Stan Sienkiewicz, The Evolution of EFT Networks from ATMs to New On-Line Debit Payment Products, Federal Reserve Bank of Philadelphia Discussion Paper (Apr. 2002), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=927473

[103] Mike Cannon, Credit Card Authorization Hold – How and When to Use, Chargeback Gurus (Dec. 26, 2021), https://www.chargebackgurus.com/blog/credit-card-authorization-holds.

I.       Introduction

Proposals to protect children and teens online are among the few issues in recent years to receive at least rhetorical bipartisan support at both the national and state level. Citing findings of alleged psychological harm to teen users,[1] legislators from around the country have moved to pass bills that would require age verification and verifiable parental consent for teens to use social-media platforms.[2] But the primary question these proposals raise is whether such laws will lead to greater parental supervision and protection for teen users, or whether they will backfire and lead teens to become less likely to use the covered platforms altogether.

The answer, this issue brief proposes, is to focus on transaction costs.[3] Or more precisely, the answer can be found by examining how transaction costs operate under the Coase theorem.

The major U.S. Supreme Court cases that have considered laws to protect children by way of parental consent and age verification all cast significant doubt on the constitutionality of such regimes under the First Amendment. The reasoning such cases have employed appears to apply a Coasean transaction-cost/least-cost-avoider analysis, especially with respect to strict scrutiny’s least-restrictive-means test.

This has important implications for recent attempts to protect teens online by way of an imposed duty of care, mandatory age verification, and/or verifiable parental consent. First, because it means these solutions are likely unconstitutional. Second, because a least-cost-avoider analysis suggests that parents are in best positioned to help teens assess the marginal costs and benefits of social media, by way of the power of the purse and through available technological means. Placing the full burden of externalities on social-media companies would reduce the options available to parents and teens, who could be excluded altogether if transaction costs are sufficiently large as to foreclose negotiation among the parties. This would mean denying teens the overwhelming benefits of social-media usage.

Part II of this brief will define transaction costs and summarize the Coase theorem, with an eye toward how these concepts can help to clarify potential spillover harms and benefits arising from teens’ social-media usage. Part III will examine three major Supreme Court cases that considered earlier parental-consent and age-verification regimes enacted to restrict minors’ access to allegedly harmful content, while arguing that one throughline in the jurisprudence has been the implicit application of least-cost-avoider analysis. Part IV will argue that, even in light of how the internet ecosystem has developed, the Coase theorem’s underlying logic continues to suggest that parents and teens working together are the least-cost avoiders of harmful internet content.

Part V will analyze proposed legislation and recently enacted bills, some of which already face challenges in the federal courts, and argue that the least-cost-avoider analysis embedded in Supreme Court precedent should continue to foreclose age-verification and parental-consent laws. Part VI concludes.

II.     The Coase Theorem and Teenage Use of Social-Media Platforms

A.    The Coase Theorem Briefly Stated and Defined

The Coase theorem has been described as “the bedrock principle of modern law and economics,”[4] and the essay that initially proposed it may be the most-cited law-review article ever published.[5] Drawn from Ronald Coase’s seminal work “The Problem of Social Cost”[6] and subsequent elaborations in the literature,[7] the theorem suggests that:

1. The problem of externalities is bilateral;
2. In the absence of transaction costs, resources will be allocated efficiently, as the parties bargain to solve the externality problem;
3. In the presence of transaction costs, the initial allocation of rights does matter; and
4. In such cases, the burden of avoiding the externality’s harm should be placed on the lowest-cost avoider, while taking into consideration the total social costs of the institutional framework.

A few definitions are in order. An externality is a side effect of an activity that is not reflected in the cost of that activity—basically, what occurs when we do something whose consequences affect other people. A negative externality occurs when a third party does not like the effects of an action. When we say that such an externality is bilateral, it is to say that it takes two to tango: only when there is a conflict in the use or enjoyment of property is there an externality problem.

Transaction costs are the additional costs borne in the process of buying or selling, separate and apart from the price of the good or service itself—i.e., the costs of all actions involved in an economic transaction. Where transaction costs are present and sufficiently large, they may prevent otherwise beneficial agreements from being concluded. Institutional frameworks determine the rules of the game, including who should bear transaction costs. In order to maximize efficiency, the Coase theorem holds that the burden of avoiding negative externalities should be placed on the party or parties that can avoid them at the lowest cost.

A related and interesting literature focuses on whether the common law is efficient, and the mechanisms by which that may come to be the case.[8] Todd J. Zywicki and Edward P. Stringham argue—contra the arguments of Judge Richard Posner—that the common law’s relative efficiency is a function of the legal process itself, rather than whether judges implicitly or explicitly adopt efficiency or wealth maximization as goals.[9] Zywicki & Stringham find both demand-side and supply-side factors that tend to promote efficiency in the common law, but note that the supply-side factors (e.g., competitive courts for litigants) have changed over time in ways that may result in diminished incentives for efficiency.[10] Their central argument is that the re-litigation of inefficient rules eventually leads to the adoption of more efficient ones.[11] Efficiency itself, they argue, is also best understood as the ability to coordinate plans, rather than as wealth maximization.[12]

In contrast to common law, there is a relative paucity of literature on whether constitutional law follows a pattern of efficiency. For example, one scholar notes that citations to Coase’s work in the corpus of constitutional-law scholarship are actually exceedingly rare.[13] This brief seeks to contribute to the law & economics literature by examining how the Supreme Court appears implicitly to have adopted one version of efficiency—the least-cost-avoider principle—in its First Amendment reviews of parental-consent and age-verification laws under the compelling-government-interest and least-restrictive-means tests.

B.     Applying the Coase Theorem to Teenage Social-Media Usage

The Coase theorem’s basic insights are useful in evaluating not only legal decisions, but also legislation. Here, this means considering issues related to children and teenagers’ online social-media usage. Social-media platforms, teenage users, and their parents are the parties at-issue in this example. While social-media platforms create incredible value for their users,[14] they also arguably impose negative externalities on both teens and their parents.[15] The question here, as it was for Coase, is how to deal with those externalities.

The common-law framework of rights in this scenario is to allow minors to enter into enforceable agreements, except where they are void for public-policy reasons. As Adam Candeub points out:

Contract law is a creature of state law, and states require parental consent for minors entering all sorts of contracts for services or receiving privileges, including getting a tattoo, obtaining a driver’s license, using a tanning facility, purchasing insurance, and signing liability waivers. As a general rule, all contracts with minors are valid, but with certain exceptions they are voidable. And even though a minor can void most contracts he enters into, most jurisdictions have laws that hold a minor accountable for the benefits he received under the contract. Because children can make enforceable contracts for which parents could end up bearing responsibility, it is a reasonable regulation to require parental consent for such contracts. The few courts that have addressed the question of the enforceability of online contracts with minors have held the contracts enforceable on the receipt of the mildest benefit.[16]

Of course, many jurisdictions have passed laws requiring age-verification for various transactions prohibited to minors, such as laws for buying alcohol or tobacco,[17] obtaining driver’s licenses,[18] and buying lottery tickets or pornography.[19] Through the Children’s Online Privacy Protection Act and its regulations, the federal government also requires that online platforms obtain verifiable parental consent before they are permitted to collect certain personal information regarding children under age 13.[20]

The First Amendment, however, has been found to protect minors’ ability to receive speech, including through commercial transactions.[21] The question therefore arises: how should the law regard minors’ ability to access information on social-media platforms? In recent years, multiple jurisdictions have responded to this question by proposing or passing age-verification and parental-consent laws for teens’ social-media usage.[22]

As will be detailed below,[23] while the internet has contributed to significant reductions in transaction costs, they are still present. Thus, in order to maximize social-media platforms’ benefits while minimizing the negative externalities they impose, policymakers should endeavor to place the burden of avoiding the harms associated with teen use on the least-cost avoider. I argue that the least-cost avoider is parents and teens working together to make marginal decisions about social-media use, including by exploiting relatively low-cost practical and technological tools to avoid harmful content. The thesis of this issue brief is that this finding is consistent with the implicit Coasean reasoning in the Supreme Court’s major First Amendment cases on parental consent and age verification.

III.   Major Supreme Court Cases on Parent Consent and Age Verification

Parental-consent and age-verification laws that seek to protect minors from harmful content are not new. The Supreme Court has had occasion to review several of them, while applying First Amendment scrutiny. An interesting aspect of this line of cases is that the Court appears implicitly to have used Coasean analysis in understanding who should bear the burden of avoiding harms associated with speech platforms.

Specifically, in each case, after an initial finding that the restrictions were content-based, the Court applied strict scrutiny. Thus, the burden was placed on the government to prove the relevant laws were narrowly tailored to a compelling government interest using the least-restrictive means. The Court’s transaction-cost analysis is implicit throughout the descriptions of the problem in each case. But the main area of analysis below will be from each case’s least-restrictive-means test section, with a focus on the compelling-state-interest test in Part III.C. Parts III.A, III.B, and III.C will deal with each of these cases in turn.

A.    United States v Playboy Entertainment Group

In United States v. Playboy Entertainment Group,[24] the Supreme Court reviewed § 505 of the Telecommunications Act of 1996, which required “cable television operators who provide channels ‘primarily dedicated to sexually-oriented programming’ either to ‘fully scramble or otherwise fully block’ those channels or to limit their transmission to hours when children are unlikely to be viewing, set by administrative regulation as the time between 10 p.m. and 6 a.m.”[25] Even prior to the regulations promulgated pursuant to the law, cable operators used technological means called “scrambling” to blur sexually explicit content for those viewers who didn’t explicitly subscribe to such content, but there were reported problems with “signal bleed” that allowed some audio and visual content to be obtained by nonsubscribers.[26] Following the regulation, cable operators responded by shifting the hours when such content would be aired—i.e., by making it unavailable for 16 hours a day. This prevented cable subscribers from viewing purchased content of their choosing at times they would prefer.[27]

The basic Coasean framework is present right from the description of the problems that the statute and regulations were trying to solve. As the Court put it:

Two essential points should be understood concerning the speech at issue here. First, we shall assume that many adults themselves would find the material highly offensive; and when we consider the further circumstance that the material comes unwanted into homes where children might see or hear it against parental wishes or consent, there are legitimate reasons for regulating it. Second, all parties bring the case to us on the premise that Playboy’s programming has First Amendment protection. As this case has been litigated, it is not alleged to be obscene; adults have a constitutional right to view it; the Government disclaims any interest in preventing children from seeing or hearing it with the consent of their parents; and Playboy has concomitant rights under the First Amendment to transmit it. These points are undisputed.[28]

In Coasean language, the parties at-issue were the cable operators, content-providers of sexually explicit programming, adult cable subscribers, and their children. Cable television provides tremendous value to its customers, including sexually explicit subscription content that is valued by those subscribers. There is, however, a negative externality to the extent that such programming may become available to children whose parents find it inappropriate. The Court noted that some parents may allow their children to receive such content, and the government disclaimed an interest in preventing such reception with parental consent. Given imperfect scrambling technology, this possible negative externality was clearly present. The question that arose was whether the transaction costs imposed by time-shifting requirements in Section 505 have the effect of restricting adults’ ability to make such viewing decisions for themselves and on behalf of their children.

After concluding that Section 505 was a content-based restriction, due to the targeting of specific adult content and specific programmers, the Court stated that when a content-based restriction is designed “to shield the sensibilities of listeners, the general rule is that the right of expression prevails, even where no less restrictive alternative exists. We are expected to protect our own sensibilities ‘simply by averting [our] eyes.’” [29]

This application of strict scrutiny does not change, the court noted, because we are dealing in this instance with children or the issue of parental consent:

No one suggests the Government must be indifferent to unwanted, indecent speech that comes into the home without parental consent. The speech here, all agree, is protected speech; and the question is what standard the Government must meet in order to restrict it. As we consider a content-based regulation, the answer should be clear: The standard is strict scrutiny. This case involves speech alone; and even where speech is indecent and enters the home, the objective of shielding children does not suffice to support a blanket ban if the protection can be accomplished by a less restrictive alternative.[30]

Again, using our Coasean translator, we can read the opinion as saying the least-cost way to avoid the negative externality of unwanted adult content is by just not looking at it, or for parents to use the means available to them to prevent their children from viewing it.

In fact, that is exactly where the Court goes, by comparing, under the least-restrictive-means test, the targeted blocking mechanism made available in Section 504 of the statute to the requirements imposed by Section 505:

[T]argeted blocking enables the Government to support parental authority without affecting the First Amendment interests of speakers and willing listeners—listeners for whom, if the speech is unpopular or indecent, the privacy of their own homes may be the optimal place of receipt. Simply put, targeted blocking is less restrictive than banning, and the Government cannot ban speech if targeted blocking is a feasible and effective means of furthering its compelling interests. This is not to say that the absence of an effective blocking mechanism will in all cases suffice to support a law restricting the speech in question; but if a less restrictive means is available for the Government to achieve its goals, the Government must use it.[31]

Moreover, the Court found that the fact that parents largely eschewed the available low-cost means to avoid the harm was not necessarily sufficient for the government to prove that it is the least-restrictive alternative:

When a plausible, less restrictive alternative is offered to a content-based speech restriction, it is the Government’s obligation to prove that the alternative will be ineffective to achieve its goals. The Government has not met that burden here. In support of its position, the Government cites empirical evidence showing that § 504, as promulgated and implemented before trial, generated few requests for household-by-household blocking. Between March 1996 and May 1997, while the Government was enjoined from enforcing § 505, § 504 remained in operation. A survey of cable operators determined that fewer than 0.5% of cable subscribers requested full blocking during that time. Id., at 712. The uncomfortable fact is that § 504 was the sole blocking regulation in effect for over a year; and the public greeted it with a collective yawn.[32]

This is because there were, in fact, other market-based means available for parents to use to avoid the harm of unwanted adult programming,[33] and the government had not proved that Section 504 could be effective with more adequate notice.[34] The Court concluded its least-restrictive means analysis by saying:

Even upon the assumption that the Government has an interest in substituting itself for informed and empowered parents, its interest is not sufficiently compelling to justify this widespread restriction on speech. The Government’s argument stems from the idea that parents do not know their children are viewing the material on a scale or frequency to cause concern, or if so, that parents do not want to take affirmative steps to block it and their decisions are to be superseded. The assumptions have not been established; and in any event the assumptions apply only in a regime where the option of blocking has not been explained. The whole point of a publicized § 504 would be to advise parents that indecent material may be shown and to afford them an opportunity to block it at all times, even when they are not at home and even after 10 p.m. Time channeling does not offer this assistance. The regulatory alternative of a publicized § 504, which has the real possibility of promoting more open disclosure and the choice of an effective blocking system, would provide parents the information needed to engage in active supervision. The Government has not shown that this alternative, a regime of added communication and support, would be insufficient to secure its objective, or that any overriding harm justifies its intervention.[35]

In Coasean language, the government’s imposition of transaction costs through time-shifting channels is not the least-cost way to avoid the harm. By publicizing the blocking mechanism of Section 504, as well as promoting market-based alternatives like VCRs to record programming for playback later or blue-screen technology that blocks scrambled video, adults would be able to effectively act as least-cost avoiders of harmful content, including on behalf of their children.

B.     Ashcroft v ACLU

In Ashcroft v. ACLU,[36] the Supreme Court reviewed a U.S. District Court’s preliminary injunction of the age-verification requirements imposed by the Children Online Protection Act (COPA), which was designed to “protect minors from exposure to sexually explicit materials on the Internet.”^[37] The law created criminal penalties “of a $50,000 fine and six months in prison for the knowing posting” for ‘commercial purposes’ of World Wide Web content that is ‘harmful to minors.’”[38] The law did, however, provide an escape hatch, through:

…an affirmative defense to those who employ specified means to prevent minors from gaining access to the prohibited materials on their Web site. A person may escape conviction under the statute by demonstrating that he

“has restricted access by minors to material that is harmful to minors—

“(A) by requiring use of a credit card, debit account, adult access code, or adult personal identification number;

“(B) by accepting a digital certificate that verifies age; or

“(C) by any other reasonable measures that are feasible under available technology.” § 231(c)(1).[39]

Here, the Coasean analysis of the problem is not stated as explicitly as in Playboy, but it is still apparent. The internet clearly provides substantial value to users, including those who want to view pornography. But there is a negative externality in internet pornography’s broad availability to minors for whom it would be inappropriate. Thus, to prevent these harms, COPA established a criminal regulatory scheme with an age-verification defense. The threat of criminal penalties, combined with the age-verification regime, imposed high transaction costs on online publishers who post content defined as harmful to minors. This leaves adults (including parents of children) and children themselves as the other relevant parties. Again, the question is: who is the least-cost avoider of the possible negative externality of minor access to pornography? The adult-content publisher or the parents, using technological and practical means?

The Court immediately went to an analysis of the least-restrictive-means test, defining the inquiry as follows:

In considering this question, a court assumes that certain protected speech may be regulated, and then asks what is the least restrictive alternative that can be used to achieve that goal. The purpose of the test is not to consider whether the challenged restriction has some effect in achieving Congress’ goal, regardless of the restriction it imposes. The purpose of the test is to ensure that speech is restricted no further than necessary to achieve the goal, for it is important to ensure that legitimate speech is not chilled or punished. For that reason, the test does not begin with the status quo of existing regulations, then ask whether the challenged restriction has some additional ability to achieve Congress’ legitimate interest. Any restriction on speech could be justified under that analysis. Instead, the court should ask whether the challenged regulation is the least restrictive means among available, effective alternatives.[40]

The Court then considered the available alternative to COPA’s age-verification regime: blocking and filtering software. They found that such tools are clearly less-restrictive means, focusing not only on the software’s granting parents the ability to prevent their children from accessing inappropriate material, but also that adults would retain access to any content blocked by the filter by simply turning it off.[41] In fact, the Court noted that the evidence presented to the District Court suggested that filters, while imperfect, were probably even more effective than the age-verification regime.[42] Finally, the Court noted that, even if Congress couldn’t require filtering software, it could encourage it through parental education, by providing incentives to libraries and schools to use it, and by subsidizing development of the industry itself. Each of these, the Court argued, would be clearly less-restrictive means of promoting COPA’s goals.[43]

In Coasean language, the Court found that parents using technological and practical means are the least-cost avoider of the harm of exposing children to unwanted adult content. Government promotion and support of those means were held up as clearly less-restrictive alternatives than imposing transaction costs on publishers of adult content.

C.    Brown v Entertainment Merchants Association

In Brown v. Entertainment Merchants Association,[44] the Court considered California Assembly Bill 1179, which prohibited the sale or rental of “violent video games” to minors.[45] The Court first disposed of the argument that the government could create a new category of speech that it considered unprotected, just because it is directed at children, stating:

The California Act is something else entirely. It does not adjust the boundaries of an existing category of unprotected speech to ensure that a definition designed for adults is not uncritically applied to children. California does not argue that it is empowered to prohibit selling offensively violent works to adults—and it is wise not to, since that is but a hair’s breadth from the argument rejected in Stevens. Instead, it wishes to create a wholly new category of content-based regulation that is permissible only for speech directed at children.

That is unprecedented and mistaken. “[M]inors are entitled to a significant measure of First Amendment protection, and only in relatively narrow and well-defined circumstances may government bar public dissemination of protected materials to them.” Erznoznik v. Jacksonville, 422 U.S. 205, 212-213, 95 S.Ct. 2736*2736 2268, 45 L.Ed.2d 125 (1975) (citation omitted). No doubt a State possesses legitimate power to protect children from harm, Ginsberg, supra, at 640-641, 88 S.Ct. 1274; Prince v. Massachusetts, 321 U.S. 158, 165, 64 S.Ct. 438, 88 L.Ed. 645 (1944), but that does not include a free-floating power to restrict the ideas to which children may be exposed. “Speech that is neither obscene as to youths nor subject to some other legitimate proscription cannot be suppressed solely to protect the young from ideas or images that a legislative body thinks unsuitable for them.” Erznoznik, supra, at 213-214, 95 S.Ct. 2268.[46]

The Court rejected that there was any “longstanding tradition” of restricting children’s access to depictions of violence, as demonstrated by copious examples of violent content in children’s books, high-school reading lists, motion pictures, radio dramas, comic books, television, music lyrics, etc. Moreover, to the extent there was a time when government enforced such regulations, the courts have eventually overturned them.[47] The fact that video games were interactive did not matter either, the Court found, as all literature is potentially interactive, especially genres like choose-your-own-adventure stories.[48]

Thus, because the law was clearly content-based, the Court applied strict scrutiny. The Court was skeptical even of whether the government had a compelling state interest, finding the law to be both seriously over- and under-inclusive. The same effects of exposure to violent content, the Court noted, could be found from covered video games and cartoons not subject to the law’s provisions. Moreover, the law allowed a parent or guardian (or any adult) to buy violent video games for their children.[49]

The Court then gets to the law’s real justification, which it summarily rejected as inconsistent with the First Amendment:

California claims that the Act is justified in aid of parental authority: By requiring that the purchase of violent video games can be made only by adults, the Act ensures that parents can decide what games are appropriate. At the outset, we note our doubts that punishing third parties for conveying protected speech to children just in case their parents disapprove of that speech is a proper governmental means of aiding parental authority.[50]

In Coasean language, the Court is saying that video games—even violent ones—are subjectively valued by those who play them, including minors. There may be negative externalities from playing such games, in that exposure to violence could be linked to psychological harm, and that they are interactive, but these content and design features are still protected speech. Placing the transaction costs on parents/adults to buy such games on behalf of minors, just in case some parents disapprove of their children playing them, is not a compelling state interest.

While the Court is only truly focused on whether there is a compelling state interest in California’s statutory scheme regulating violent video games, some of the language would equally apply to a least-restrictive means analysis:

But leaving that aside, California cannot show that the Act’s restrictions meet a substantial need of parents who wish to restrict their children’s access to violent video games but cannot do so. The video-game industry has in place a voluntary rating system designed to inform consumers about the content of games. The system, implemented by the Entertainment Software Rating Board (ESRB), assigns age-specific ratings to each video game submitted: EC (Early Childhood); E (Everyone); E10 + (Everyone 10 and older); T (Teens); M (17 and older); and AO (Adults Only—18 and older). App. 86. The Video Software Dealers Association encourages retailers to prominently display information about the ESRB system in their stores; to refrain from renting or selling adults-only games to minors; and to rent or sell “M” rated games to minors only with parental consent. Id., at 47. In 2009, the Federal Trade Commission (FTC) found that, as a result of this system, “the video game industry outpaces the movie and music industries” in “(1) restricting target-marketing of mature-rated products to children; (2) clearly and prominently disclosing rating information; and (3) restricting children’s access to mature-rated products at retail.” FTC, Report to Congress, Marketing Violent Entertainment to Children 30 (Dec.2009), online at http://www. ftc.gov/os/2009/12/P994511violent entertainment.pdf (as visited June 24, 2011, and available in Clerk of Court’s case file) (FTC Report). This system does much to ensure that minors cannot purchase seriously violent games on their own, and that parents who care about the matter can readily evaluate the games their children bring home. Filling the remaining modest gap in concerned parents’ control can hardly be a compelling state interest.

And finally, the Act’s purported aid to parental authority is vastly overinclusive. Not all of the children who are forbidden to purchase violent video games on their own have parents who care whether they purchase violent video games. While some of the legislation’s effect may indeed be in support of what some parents of the restricted children actually want, its entire effect is only in support of what the State thinks parents ought to want. This is not the narrow tailoring to “assisting parents” that restriction of First Amendment rights requires.[51]

In sum, the Court suggests that the law would not be narrowly tailored, because there are already market-based systems in place to help parents and minors make informed decisions about which video games to buy—most importantly from the rating system that judges appropriateness by age and offers warnings about violence. Government paternalism is simply insufficient to justify imposing new transaction costs on parents and minors who wish to buy even violent video games.

Interestingly, the concurrence of Justice Samuel Alito, joined by Chief Justice John Roberts, also contains some language that could be interpreted through a Coasean lens. The concurrence allows, in particular, the possibility that harms from interactive violent video games may differ from other depictions of violence that society has allowed children to view, although it concludes that reasonable minds may differ.[52] In other words, the concurrence basically notes that the negative externalities may be greater than the majority opinion would allow, but nonetheless, that Justices Alito and Roberts agreed the law was not drafted in a constitutional manner that comports with the obscenity exception to the First Amendment.

Nonetheless, it appears the Court applies an implicit Coasean framework when it rejects the imposition of transaction costs on parents and minors to gain access to protected speech—in this case, violent video games. Parents and minors remain the least-cost avoiders of the potential harms of violent video games.

IV.   Coase Theorem Applied to Age-Verification and Verifiable-Consent Laws

As outlined above, the issue is whether social media needs age-verification and parental-consent laws in order to address negative externalities to minor users. This section will analyze this question under the Coasean framework introduced in Part II.

The basic argument proceeds as follows:

1. Transaction costs for age verification and verifiable consent from parents and/or teens are sufficient large to prevent a bargain from being struck;
2. The lowest-cost avoiders are parents and teens working together, using practical and technological means, including low-cost monitoring and filtering services, to make marginal decisions about minors’ social-media use; and
3. Placing the transaction costs on social-media companies to obtain age verification and verifiable consent from parents and/or teens would actually reduce their ability to make marginal decisions about minors’ social-media use, as social-media companies will respond by investing more in excluding minors from access than in creating safe and vibrant spaces for interaction.

Part IV.A will detail the substantial transaction costs associated with obtaining age verification and verifiable parental consent. Part IV.B argues that parents and teens working together using practical and technological means are the lowest-cost avoiders of the harms of social-media use. Part IV.C will consider the counterfactual scenario of placing the transaction costs on social-media companies and argue that the result would be teens’ exclusion from social media, to their detriment, as well as the detriment of parents who would have made different choices.

A.    Transaction Costs, Age Verification, and Verifiable Parental Consent[53]

As Coase taught, in a world without transaction costs (or where such costs are sufficiently low), age-verification laws or mandates to obtain verifiable parental consent would not matter, because the parties would bargain to arrive at an efficient solution. Because there are high transaction costs that prevent such bargains from being easily struck, making the default that teens cannot join social media without verifiable parental consent could have the effect of excluding them from the great benefits of social media usage altogether.[54]

There is considerable evidence that, even despite the internet and digital technology serving to reduce transaction costs considerably across a wide range of fronts,[55] transaction costs remain high when it comes to age verification and verifiable parental consent. A data point that supports this conclusion is the experience of social-media platforms under the Children’s Online Privacy Protection Act (COPPA).[56] In their working paper “COPPAcalypse? The YouTube Settlement’s Impact on Kids Content,”[57] Garrett Johnson, Tesary Lin, James C. Cooper, & Liang Zhong summarized the issue as follows:

The Children’s Online Privacy Protection Act (COPPA), and its implementing regulations, broadly prohibit operators of online services directed at children under 13 from collecting personal information without providing notice of its data collection and use practices and obtaining verifiable parental consent. Because obtaining verifiable parental consent for free online services is difficult and rarely cost justified, COPPA essentially acts as a de facto ban on the collection of personal information by providers of free child-directed content. In 2013, the FTC amended the COPPA rules to include in the definition of personal information “persistent identifier that can be used to recognize a user over time and across different Web sites or online services,” such as a “customer number held in a cookie . . . or unique device identifier.” This regulatory change meant that, as a practical matter, online operators who provide child-directed content could no longer engage in personalized advertising.

On September 4, 2019, the FTC entered into a consent agreement with YouTube to settle charges that it had violated COPPA. The FTC’s allegations focused on YouTube’s practice of serving personalized advertising on child-directed content at children without obtaining verifiable parental consent. Although YouTube maintains it is a general audience website and users must be at least 13 years old to obtain a Google ID (which makes personalized advertising possible), the FTC complaint alleges that YouTube knew that many of its channels were popular with children under 13, citing YouTube’s own claims to advertisers. The settlement required YouTube to identify child-directed channels and videos and to stop collecting personal information from visitors to these channels. In response, YouTube required channel owners producing [“made-for-kids”] MFK content to designate either their entire channels or specific videos as MFK, beginning on January 1, 2020. YouTube supplemented these self-designations with an automated classifier designed to identify content that was likely directed at children younger than 13.9 In so doing, YouTube effectively shifted liability under COPPA to the channel owners, who could face up to $42,530 in fines per video if they fail to self-designate and are not detected by YouTube’s classifier.[58]

The rule change and settlement increased the transaction costs imposed on social-media platforms by requiring verifiable parental consent. YouTube’s economically rational response was to restrict the content creators’ ability to benefit from (considerably more lucrative) personalized advertising. The end result was less content created for children, with competitive effects to boot:

Consistent with a loss in personalized ad revenue, we find that child-directed content creators produce 13% less content and pivot towards producing non-child-directed content. On the demand side, views of child-directed channels fall by 22%. Consistent with the platform’s degraded capacity to match viewers to content, we find that content creation and content views become more concentrated among top child-directed YouTube channels.[59]

This is not the only finding regarding COPPA’s role in reducing the production of content for children. The president of the App Association, a global trade association for small and medium-sized technology companies, presented extensively at the Federal Trade Commission’s (FTC) 2019 COPPA Workshop.[60] The testimony from App Association President Morgan Reed detailed that the transaction costs associated with obtaining verifiable parental consent did little to enhance parental control, but much to reduce the quality and quantity of content directed to children. But it is worth highlighting Reed’s constant use of the words “friction,” “restriction,” and “cost” to describe how the institutional environment of COPPA affects the behavior of the social media platforms, parents, and children. While noting that general audience content is “unfettered, meaning that you don’t feel restricted by what you can get to, how you do it. It’s easy, it’s low friction. Widely available. I can get it on any platform, in any case, in any context and I can get to it rapidly,” COPPA-regulated apps and content are, Reed said, all about:

Friction, restriction, and cost. Every layer of friction you add alters parent behavior significantly. We jokingly refer to it as the over the shoulder factor. If a parent wants access to something and they have to pass it from the back seat to the front seat of the car more than one time, the parent moves on to the next thing. So the more friction you add to an application directed at children the less likely it is that the parent is going to take the steps necessary to get through it because the competition, of course, is as I said, free, unfettered, widely available. Restriction. Kids balk against some of the restrictions. I can’t get to this, I can’t do that. And they say that to the parent. And from the parent’s perspective, fine, I’ll just put in a different age date. They’re participating, they’re parenting but they’re not using the regulatory construction that we all understand. …

The COPPA side, expensive, onerous or friction full. We have to find some way around that. Restrictive, fewer features, fewer capabilities, less known or available, and it’s entertaining-ish. …

Is COPPA the barrier? I thought this quote really summed it up. “Seamlessness is expected. But with COPPA, seamlessness is impossible.” And that has been one of the single largest areas of concern. Our folks are looking to provide a COPPA compliant environment. And they’re finding doing VPC is really hard. We want to make it this way, we just walked away. And why do they want to do it? We wanted to create a hub for kids to promote creativity. So these are not folks who are looking to take data and provide interest based advertising. They’re trying to figure out how to do it so they can build an engaging product. Parental consent makes the whole process very complicated. And this is the depressing part. …

We say that VPC is intentional friction. It’s clear from everything we’ve heard in the last two panels that the authors of COPPA, we don’t really want information collected on kids. So friction is intentional. And this is leading to the destruction of general audience applications basically wiping out COPPA apps off the face of the map.[61]

Reed’s use of the word “friction” is particularly enlightening. Mike Munger has often described transaction costs as frictions, explaining that, to consumers, all costs are transaction costs.[62] When higher transaction costs are imposed on social-media platforms, end users feel the impact. In this case, the result is that children and parents receive less quality children’s apps and content.

A similar example can be seen in the various battles between traditional media and social-media companies in Australia, Canada, and the EU, where laws have been passed that would require platforms to pay for linking to certain news content.[63] Because these laws raise transaction costs, social-media platforms have responded by restricting access to news links,[64] to the detriment of users and the news-media organizations themselves. In other words, much like with verifiable parental consent, the intent of these laws is thwarted by the underlying economics.

More evidence that imposing transaction costs on social-media companies can have the effect of diminishing the user experience can be found in the preliminary injunction issued by the U.S. District Court in Austin, Texas in Free Speech Coalition Inc. v. Colmenero.[65] The court cited evidence from the plaintiff’s complaint that included bills for “several commercial verification services, showing that they cost, at minimum, $40,000.00 per 100,000 verifications.”[66] The court also noted that “[Texas law] H.B. 1181 imposes substantial liability for violations, including $10,000.00 per day for each violation, and up to $250,000.00 if a minor is shown to have viewed the adult content.”[67]

Moreover, the transaction costs in this example also include the subjective costs borne by those who actually go through with verifying their age to access pornography. As the court noted “the law interferes with the Adult Video Companies’ ability to conduct business, and risks deterring adults from visiting the websites.”[68] The court issued a preliminary injunction against the law’s age-verification provision, finding that other means—such as content-filtering software—are clearly more effective than age verification to protect children from unwanted content.[69]

In sum, transaction costs for age verification and verifiable parental consent are sufficiently high as to prevent an easy bargain from being struck. Thus, which party bears the burden of those costs will determine the outcome. The lessons from COPPA, news-media laws, and online-pornography age-verification laws are clear: if the transaction costs are imposed on the online platforms and apps, it will lead to access restrictions on the speech those platforms provide, almost all of which is protected speech. This is the type of collateral censorship that the First Amendment is designed to avoid.[70]

B.     Parents and Teens as the Least-Cost Avoiders of Negative Externalities

If transaction costs due to online age-verification and verifiable-parent-consent laws are substantial, the question becomes which party or parties should be subject to the burden of avoiding the harms arising from social-media usage.

It is possible, in theory, that social-media platforms are the best-positioned to monitor and control content posted to their platforms—for instance, when it comes to harms associated with anonymous or pseudonymous accounts imposing social costs on society.[71] In such cases, a duty of care that would allow for intermediary liability against social-media companies may make sense.[72]

On the other hand, when it comes to online age-verification and parental-consent laws, widely available practical and technological means appear to be lowest-cost way to avoid the negative externalities associated with social-media usage. As NetChoice put it in their complaint against Arkansas’ social-media age-verification law, “[p]arents have myriad ways to restrict their children’s access to online services and to keep their children safe on such services.”[73]

In their complaint, NetChoice recognizes the subjective nature of negative externalities, stating:

Just as people inevitably have different opinions about what books, television shows, and video games are appropriate for minors, people inevitably have different views about whether and to what degree online services are appropriate for minors. While many minors use online services in wholesome and productive ways, online services, like many other technologies, can be abused in ways that may harm minors.[74]

They then expertly list all the ways that parents can take control and help their children avoid online harms, including with respect to the decisions to buy devices for their children and to set terms for how and when they are permitted to use them.[75] Parents can also choose to use tools from cell-phone carriers and broadband providers to block certain apps and sites from their children’s devices, or to control with whom their children can communicate and for how long they can use the devices.[76] They also point to wireless routers that allow for parents to filter and monitor online content;[77] parental controls at the device level;[78] third-party filtering applications;[79] and numerous tools offered by NetChoice members that all allow for relatively low-cost monitoring and control by parents and even teen users acting on their own behalf.[80] Finally, they note that NetChoice members, in response to market demand,[81]expend significant resources curating content to make sure it’s appropriate.[82]

The recent response from the Australian government to the proposed “Roadmap for Age Verification”[83] buttresses this analysis. The government pulled back from plans to “force adult websites to bring in age verification following concerns about privacy and the lack of maturity of the technology.”[84] In particular, the government noted that:

It is clear from the Roadmap that at present, each type of age verification or age assurance technology comes with its own privacy, security, effectiveness and implementation issues. For age assurance to be effective, it must:

• work reliably without circumvention;
• be comprehensively implemented, including where pornography is hosted outside of Australia’s jurisdiction; and
• balance privacy and security, without introducing risks to the personal information of adults who choose to access legal pornography.

Age assurance technologies cannot yet meet all these requirements. While industry is taking steps to further develop these technologies, the Roadmap finds that the age assurance market is, at this time, immature.

The Roadmap makes clear that a decision to mandate age assurance is not ready to be taken.[85]

As a better solution, the government offered “[m]ore support and resources for families,”[86] including promoting tools already available in the marketplace to help prevent children from accessing inappropriate content like pornography,[87] and promoting education for both parents and children on how to avoid online harms.[88]

In sum, this is all about transaction costs. The least-cost avoider from negative externalities imposed by social-media usage are the parents and teens themselves, working together to make marginal decisions about how to use these platforms through the use of widely available practical and technological means.

C.    Teen Exclusion Online and Reduced Parental Involvement in Social-Media Usage Decisions

If the burden of avoiding negative externalities is placed on social-media platforms, the result could be considerable collateral censorship of protected speech. This is because of transaction costs, as explained above in Part IV.A. Thus, while one could argue that the externalities imposed by social-media platforms on teen users and their parents represent a market failure, this is not the end of the analysis. Transaction costs help to explain that the institutional environment we create fosters the rules of the game that platforms, parents, and teens follow. If transaction costs are too high and placed incorrectly on social-media platforms, parents and teens’ ability to control how they use social media will actually suffer.

As can be seen most prominently in the COPPA examples discussed above,[89] the burden of obtaining verifiable parental consent leads to platforms reallocating investments into the exclusion of the protected class—in that case, children under age 13—that could otherwise go toward creating a safe and vibrant community from which children could benefit. Thus, proposals like COPPA 2.0,[90] which would extend the need for verifiable consent to teens, could yield an equivalent result of greater exclusion of teens. State laws that would require age verification and verifiable parental consent for teens are likely to produce the same result, as well. The irony, of course, is that parental consent laws would actually reduce the available choices for those parents who see the use value for their teenagers.

In sum, the economics of transaction costs explains why age-verification and verifiable-parental-consent laws will not satisfy their proponents’ stated objectives. As with minimum-wage laws[91] and rent control,[92] economics helps to explain the counterintuitive finding that well-intentioned laws can actually produce the exact opposite end result. Here, that means age-verification and verifiable-parental-consent laws lead to parents and teens being less able to make meaningful and marginal decisions about the costs and benefits of their own social-media usage.

V.     The Unconstitutionality of Social-Media Verification and Verifiable-Consent Laws

Bringing this all together, Part V will consider the constitutionality of the enacted and proposed laws on age verification and verifiable parental consent under the First Amendment. As several courts have already suggested, these laws will not survive First Amendment scrutiny.

The first question is whether these laws will be subject to strict scrutiny (because they are content-based) or instead to intermediate scrutiny as content-neutral regulations. There is a possibility that it will not matter, because a court could find—as one already has—that such laws burden more speech than necessary anyway. Part V.A will take up these questions.

The second set of questions is whether, assuming strict scrutiny applies, these enacted and proposed laws could survive the least-restrictive-means test. Part V.B will consider this set of questions and argue that, as the lowest-cost avoiders, parents and teens working together using widely available practical and technological means to avoid negative externalities also represents the least-restrictive means to promote the government’s interest in protecting minors from the harms of social media.

A.    Questions of Content Neutrality

The first important question is whether laws that attempt to protect minors from externalities associated with social-media usage are content-neutral. One argument that has been forwarded is that they are simply content-neutral contract laws that shift the consent default to parents before teens can establish an ongoing contractual relationship with a social-media company by creating a profile.[93]

Before delving into whether that argument could work, it is worth considering laws that are clearly content-based to help tell the difference. For instance, the Texas law challenged in Free Speech Coalition v. Colmenero is clearly content-based, because “the regulation is based on whether content contains sexual material.”[94]

Similarly, laws like the Kids Online Safety Act (KOSA)[95] are content-based, in that they require covered platforms to take:

reasonable measures in its design or operation of products and services to prevent or mitigate the following:

• Consistent with evidence-informed medical information, the following mental health disorders: anxiety, depression, eating disorders, substance use disorders, and suicidal behaviors.

• Patterns of use that indicate or encourage addiction-like behaviors.

• Physical violence, online bullying, and harassment of the minor.

• Sexual exploitation and abuse.

• Promotion and marketing of narcotic drugs (as defined in section 102 of the Controlled Substances Act (21 U.S.C. 802)), tobacco products, gambling, or alcohol.

• Predatory, unfair, or deceptive marketing practices, or other financial harms.[96]

While parts 4-6 and actual physical violence all constitute either unprotected speech or conduct, decisions about how to present information from part 2 is arguably protected speech.[97] Even true threats like online bullying and harassment are speech subject to at least some First Amendment scrutiny, in that they would require some type of mens rea to be constitutional.[98] Part 1 may be unconstitutionally vague as written.[99] Moreover, 1-3 are clearly content-based, in that it is necessary to consider the content presented, which will include at least some protected speech. This equally applies to the California Age Appropriate Design Code,[100] which places an obligation on covered companies to identify and mitigate speech that is harmful or potentially harmful to users under 18 years old, and to prioritize speech that promotes such users’ well-being and best interests.[101]

In each of these cases, it would be difficult to argue that strict scrutiny ought not apply. On the other hand, some have argued that the Utah and Arkansas laws requiring age verification and verifiable parental consent are simply content-neutral regulations of contract formation, which can be considered independently of speech.[102] Arkansas has argued that Act 689’s age-verification requirements are “merely a content-neutral regulation on access to speech at particular ‘locations,’ so intermediate scrutiny should apply.”[103]

But even in NetChoice v. Griffin,[104] the U.S. District Court in Arkansas, while skeptical that the law was content-neutral,[105] proceeded as if it was and still found, in granting a preliminary injunction, that the age-verification law “is likely to unduly burden adult and minor access to constitutionally protected speech.”[106] Similarly, the U.S. District Court for the Northern District of California found that all major provisions of California’s AADC were likely unconstitutional under a lax commercial-speech standard.[107]

Nonetheless, there are strong arguments that these laws are content-based. As the court in Griffin put it:

Deciding whether Act 689 is content-based or content-neutral turns on the reasons the State gives for adopting the Act. First, the State argues that the more time a minor spends on social media, the more likely it is that the minor will suffer negative mental health outcomes, including depression and anxiety. Second, the State points out that adult sexual predators on social media seek out minors and victimize them in various ways. Therefore, to the State, a law limiting access to social media platforms based on the user’s age would be content-neutral and require only intermediate scrutiny.

On the other hand, the State points to certain speech-related content on social media that it maintains is harmful for children to view. Some of this content is not constitutionally protected speech, while other content, though potentially damaging or distressing, especially to younger minors, is likely protected nonetheless. Examples of this type of speech include depictions and discussions of violence or self-harming, information about dieting, so-called “bullying” speech, or speech targeting a speaker’s physical appearance, race or ethnicity, sexual orientation, or gender. If the State’s purpose is to restrict access to constitutionally protected speech based on the State’s belief that such speech is harmful to minors, then arguably Act 689 would be subject to strict scrutiny.

During the hearing, the State advocated for intermediate scrutiny and framed Act 689 as “a restriction on where minors can be,” emphasizing it was “not a speech restriction” but “a location restriction.” The State’s briefing analogized Act 689 to a restriction on minors entering a bar or a casino. But this analogy is weak. After all, minors have no constitutional right to consume alcohol, and the primary purpose of a bar is to serve alcohol. By contrast, the primary purpose of a social media platform is to engage in speech, and the State stipulated that social media platforms contain vast amounts of constitutionally protected speech for both adults and minors. Furthermore, Act 689 imposes much broader “location restrictions” than a bar does. The Court inquired of the State why minors should be barred from accessing entire social media platforms, even though only some of the content was potentially harmful to them, and the following colloquy ensued:

THE COURT: Well, to pick up on Mr. Allen’s analogy of the mall, I haven’t been to the Northwest Arkansas mall in a while, but it used to be that there was a restaurant inside the mall that had a bar. And so certainly minors could not go sit at the bar and order up a drink, but they could go to the Barnes & Noble bookstore or the clothing store or the athletic store. Again, borrowing Mr. Allen’s analogy, the gatekeeping that Act 689 imposes is at the front door of the mall, not the bar inside the mall; yes?

THE STATE: The state’s position is that the whole mall is a bar, if you want to continue to use the analogy.

THE COURT: The whole mall is a bar?

THE STATE: Correct.

Clearly, the state’s analogy is not persuasive.

NetChoice argues that Act 689 is not a content-neutral restriction on minors’ ability to access particular spaces online, and the fact that there are so many exemptions to the definitions of “social media company” and “social media platform” proves that the State is targeting certain companies based either on a platform’s content or its viewpoint. Indeed, Act 689’s definitions and exemptions do seem to indicate that the State has selected a few platforms for regulation while ignoring all the rest. The fact that the State fails to acknowledge this causes the Court to suspect that the regulation may not be content neutral. “If there is evidence that an impermissible purpose or justification underpins a facially content-neutral restriction, for instance, that restriction may be content-based.” City of Austin v. Reagan Nat’l Advertising of Austin, LLC, 142 S. Ct. 1464, 1475 (2022).[108]

Utah’s laws HB 311 and 152 would also seem to suffer from a similar defect as KOSA and AADC,[109] though they have not yet been litigated.

B.     Least-Restrictive Means Is to Promote Monitoring and Filtering

Assuming that courts do, in fact, find that these laws are content-based, strict scrutiny would apply, including the least-restrictive-means test.[110] In that case, the caselaw is clear: the least-restrictive means to achieve the government’s interest of protecting minors from social media’s speech and design problems is to promote low-cost monitoring and filtering.

First, however, it is also worth inquiring whether the government would be able to establish a compelling state interest, as the Court discussed in Brown. The Court’s strong skepticism of government paternalism[111] applies equally to the verifiable-parental-consent laws enacted in Arkansas and Utah, as well as COPPA 2.0. Aiding parental consent likely fails to “meet a substantial need of parents who wish to restrict their children’s access”[112] to social media, but can’t do so, to use the late Justice Antonin Scalia’s language. Moreover, the “purported aid to parental authority” is likely to be found to be “vastly overinclusive” because “[n]ot all of the children who are forbidden” to join social media on “their own have parents who care whether” they do so.[113] While such laws “may indeed be in support of what some parents of the restricted children actually want, its entire effect is only in support of what the State thinks parents ought to want. This is not the narrow tailoring to ‘assisting parents’ that restriction of First Amendment rights requires.”[114]

As argued clearly above, Ashcroft is strong precedent that promoting the practical and technological means available in the marketplace, outlined by NetChoice in its brief in Griffin, is less restrictive than age-verification laws to protect minors from harms associated with social-media usage.[115] In fact, there is a strong argument that the market has subsequently produced more and more effective tools than were available even then. This makes it exceedingly unlikely that the Supreme Court will change its mind.

While some have argued that Justice Clarence Thomas’ dissent in Brown offers roadmap to reject these precedents,[116] there is little basis for that conclusion. First, Thomas’ dissent in Brown was not joined by any other members of the Supreme Court.[117] Second, Justice Thomas joined the majority in Ashcroft v. ACLU, suggesting he probably still sees age-verification laws as unconstitutional.[118] Even Associate Justice Samuel Alito issued a concurrence to the majority in that case,[119] expressing skepticism of Justice Thomas’ approach.[120]  Third, it seems unlikely that the newer conservative justices, whose jurisprudence has been more speech-protective by nature,[121] would join Justice Thomas in his opinion on the right of children to receive speech. And far from being vague on the issue of whether a minor has a right to receive speech, [122] Justice Scalia’s majority opinion clearly stated that:

[M]inors are entitled to a significant measure of First Amendment protection, and only in relatively narrow and well-defined circumstances may government bar public dissemination of protected materials to them… but that does not include a free-floating power to restrict the ideas to which children may be exposed.[123]

Precedent is strong against age-verification and parental-consent laws, and there is no reason to think the personnel changes on the Supreme Court would change the analysis.

In sum, straightforward applications of Brown and Ashcroft doom these new social-media laws.

VI.   Conclusion

This issue brief has two main conclusions, one of interest to the scholarship of applying law & economics to constitutional law, and the other to the policy and legal questions surrounding social-media age-verification and parental-consent laws:

1. The Supreme Court appears to implicitly adopt a Coasean framework in its approach to parental-consent and age-verification laws in the three major precedents of Playboy, Ashcroft, and Brown; and
2. The application of this least-cost avoider analysis in the least-restrictive-means test, in particular, is likely to doom these laws constitutionally, but also as a matter of economically grounded policy.

In conclusion, these online age-verification laws should be rejected. Why? The answer is transaction costs.

[1] See, e.g., Kirsten Weir, Social Media Brings Benefits and Risks to Teens. Here’s How Psychology Can Help Identify a Path Forward, 54 Monitor on Psychology 46 (Sep. 1, 2023), https://www.apa.org/monitor/2023/09/protecting-teens-on-social-media.

[2] See, e.g., Khara Boender, Jordan Rodell, & Alex Spyropoulos, The State of Affairs: What Happened in Tech Policy During 2023 State Legislative Sessions?, Project Disco (Jul. 25, 2023), https://www.project-disco.org/competition/the-state-of-affairs-state-tech-policy-in-2023 (noting laws passed and proposed addressing children’s online safety at the state level, including California’s Age-Appropriate Design Code and age-verification laws in both Arkansas and Utah, all of which will be considered below).

[3] With apologies to Mike Munger for borrowing the title of his excellent podcast, invoked several times in this issue brief; see The Answer Is Transaction Costs, https://podcasts.apple.com/us/podcast/the-answer-is-transaction-costs/id1687215430 (last accessed Sept. 28, 2023).

[4] Steven G. Medema, “Failure to Appear”: The Use of the Coase Theorem in Judicial Opinions, at 4, Dep’t of Econ. Duke Univ., Working Paper No. 2.1 (2019), available at https://hope.econ.duke.edu/sites/hope.econ.duke.edu/files/Medema%20workshop%20paper.pdf.

[5] Fred R. Shapiro & Michelle Pearse, The Most Cited Law Review Articles of All Time, 110 Mich. L. Rev. 1483, 1489 (2012).

[6] R.H. Coase, The Problem of Social Cost, 3 J. L. & Econ. 1 (1960).

[7] See generally Steven G. Medema, The Coase Theorem at Sixty, 58 J. Econ. Lit. 1045 (2020).

[8] Todd J. Zywicki & Edward Peter Stringham, Common Law and Economic Efficiency, Geo. Mason Univ.. L. & Econ. Rsch., Working Paper No. 10-43 (2010), available at https://www.law.gmu.edu/assets/files/publications/working_papers/1043CommonLawandEconomicEfficiency.pdf.

[9] See id. at 4.

[10] See id. at 3.

[11] See id. at 10.

[12] See id. at 34.

[13] Medema, supra note 4, at 39.

[14] See, e.g., Matti Cuorre & Andrew K. Przybylski, Estimating the Association Between Facebook Adoption and Well-Being in 72 Countries, 10 Royal Soc’y Open Sci. 1 (2023), https://royalsocietypublishing.org/doi/epdf/10.1098/rsos.221451; Sabrina Cipoletta, Clelia Malighetti, Chiara Cenedese, & Andrea Spoto, How Can Adolescents Benefit from the Use of Social Networks? The iGeneration on Instagram, 17 Int. J. Environ. Res. Pub. Health 6952 (2020), https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7579040.

[15] See Jean M. Twenge, Thomas E. Joiner, Megan L Rogers, & Gabrielle N. Martin, Increases in Depressive Symptoms, Suicide-Related Outcomes, and Suicide Rates Among U.S. Adolescents After 2010 and Links to Increased New Media Screen Time, 6 Clinical Psych. Sci. 3 (2018), available at https://courses.engr.illinois.edu/cs565/sp2018/Live1_Depression&ScreenTime.pdf.

[16] Adam Candeub, Age Verification for Social Media: A Constitutional and Reasonable Regulation, FedSoc Blog (Aug. 7, 2023), https://fedsoc.org/commentary/fedsoc-blog/age-verification-for-social-media-a-constitutional-and-reasonable-regulation.

[17] See Wikipedia, List of Alcohol Laws of the United States, https://en.wikipedia.org/wiki/List_of_alcohol_laws_of_the_United_States (last accessed Sep. 28, 2023); Wikipedia, U.S. History of Tobacco Minimum Purchase Age by State, https://en.wikipedia.org/wiki/U.S._history_of_tobacco_minimum_purchase_age_by_state (last accessed Sep. 28, 2023).

[18] See Wikipedia, Driver’s Licenses in the United States, https://en.wikipedia.org/wiki/Driver%27s_licenses_in_the_United_States (last accessed Sep. 28, 2023).

[19] See Wikipedia, Gambling Age, https://en.wikipedia.org/wiki/Gambling_age (last accessed Sep. 28, 2023) (table on minimum age for lottery tickets and casinos by state). As far as this author is aware, every state and territory requires identification demonstrating the buyer is at least 18 years old to make a retail purchase of a pornographic magazine or video.

[20] See 15 U.S.C. § 6501, et seq. (2018); 16 CFR Part 312.

[21] See infra Part III. See Brown v. Ent. Merch. Ass’n, 564 U.S. 786, 794 (2011) (“California does not argue that it is empowered to prohibit selling offensively violent works to adults—and it is wise not to, since that is but a hair’s breadth from the argument rejected in Stevens. Instead, it wishes to create a wholly new category of content-based regulation that is permissible only for speech directed at children. That is unprecedented and mistaken. ‘[M]inors are entitled to a significant measure of First Amendment protection, and only in relatively narrow and well-defined circumstances may government bar public dissemination of protected materials to them…’ No doubt a State possesses legitimate power to protect children from harm… but that does not include a free-floating power to restrict the ideas to which children may be exposed. ‘Speech that is neither obscene as to youths nor subject to some other legitimate proscription cannot be suppressed solely to protect the young from ideas or images that a legislative body thinks unsuitable for them.’”) (internal citations omitted).

[22] See infra Part V.

[23] See infra Part IV.

[24] 529 U.S. 803 (2000).

[25] Id. at 806.

[26] See id.

[27] See id. at 806-807.

[28] Id. at 811.

[29] Id. at 813 (internal citation omitted).

[30] Id. at 814.

[31] Id. at 815.

[32] Id. at 816.

[33] See id. at 821 (“[M]arket-based solutions such as programmable televisions, VCR’s, and mapping systems []which display a blue screen when tuned to a scrambled signal[] may eliminate signal bleed at the consumer end of the cable.”).

[34] See id. at 823 (“The Government also failed to prove § 504 with adequate notice would be an ineffective alternative to § 505.”).

[35] Id. at 825-826.

[36] 542 U.S. 656 (2004).

[37] Id. at 659.

[38] Id. at 661.

[39] Id. at 662.

[40] Id. at 666.

[41] See id. at 667 (“Filters are less restrictive than COPA. They impose selective restrictions on speech at the receiving end, not universal restrictions at the source. Under a filtering regime, adults without children may gain access to speech they have a right to see without having to identify themselves or provide their credit card information. Even adults with children may obtain access to the same speech on the same terms simply by turning off the filter on their home computers. Above all, promoting the use of filters does not condemn as criminal any category of speech, and so the potential chilling effect is eliminated, or at least much diminished. All of these things are true, moreover, regardless of how broadly or narrowly the definitions in COPA are construed.”).

[42] See id. at 667-669.

[43] See id. at 669-670.

[44] 564 U.S. 786 (2011).

[45] See id. at 787.

[46] Id. at 793-795.

[47] See id. at 794-797.

[48] See id. at 796-799.

[49] See id. at 799-802.

[50] Id. at 801.

[51] Id. at 801-804.

[52] See id. at 812 (J. Alito, concurring):

“There is a critical difference, however, between obscenity laws and laws regulating violence in entertainment. By the time of this Court’s landmark obscenity cases in the 1960’s, obscenity had long been prohibited, See Roth v. U.S., 354 U.S. 476, at 484-485, and this experience had helped to shape certain generally accepted norms concerning expression related to sex.

There is no similar history regarding expression related to violence. As the Court notes, classic literature contains descriptions of great violence, and even children’s stories sometimes depict very violent scenes.

Although our society does not generally regard all depictions of violence as suitable for children or adolescents, the prevalence of violent depictions in children’s literature and entertainment creates numerous opportunities for reasonable people to disagree about which depictions may excite “deviant” or “morbid” impulses. See Edwards & Berman, Regulating Violence on Television, 89 Nw. U.L.Rev. 1487, 1523 (1995) (observing that the Miller test would be difficult to apply to violent expression because “there is nothing even approaching a consensus on low-value violence”).

Finally, the difficulty of ascertaining the community standards incorporated into the California law is compounded by the legislature’s decision to lump all minors together. The California law draws no distinction between young children and adolescents who are nearing the age of majority.”

See also id. at 819 (Alito, J., concurring) (“If the technological characteristics of the sophisticated games that are likely to be available in the near future are combined with the characteristics of the most violent games already marketed, the result will be games that allow troubled teens to experience in an extraordinarily personal and vivid way what it would be like to carry out unspeakable acts of violence.”).

[53] The following sections are adapted from Ben Sperry, Right to Anonymous Speech, Part 3: Anonymous Speech and Age-Verification Laws, Truth on the Market (Sep. 11, 2023), https://truthonthemarket.com/2023/09/11/right-to-anonymous-speech-part-3-anonymous-speech-and-age-verification-laws.

[54] See Ben Sperry, Online Safety Bills Will Mean Kids Are No Longer Seen or Heard Online, The Hill (May 12, 2023), https://thehill.com/opinion/congress-blog/4002535-online-safety-bills-will-mean-kids-are-no-longer-seen-or-heard-online;  Ben Sperry, Bills Aimed at ‘Protecting’ Kids Online Throw the Baby out with the Bathwater, The Hill (Jul. 26, 2023), https://thehill.com/opinion/congress-blog/4121324-bills-aimed-at-protecting-kids-online-throw-the-baby-out-with-the-bathwater; Przybylski & Vuorre, supra note 14; Mesfin A. Bekalu, Rachel F. McCloud, & K. Viswanath, Association of Social Media Use With Social Well-Being, Positive Mental Health, and Self-Rated Health: Disentangling Routine Use From Emotional Connection to Use, 42 Sage J. 69S, 69S-80S (2019), https://journals.sagepub.com/doi/full/10.1177/1090198119863768.

[55] See generally Michael Munger, Tomorrow 3.0: Transaction Costs and the Sharing Economy, Cambridge University Press (Mar. 22, 2018).

[56] The Future of the COPPA Rule: An FTC Workshop Part 2, Federal Trade Commission (Oct. 7, 2019), available at https://www.ftc.gov/system/files/documents/public_events/1535372/transcript_of_coppa_workshop_part_2_1.pdf.

[57] Garrett A. Johnson, Tesary Lin, James C. Cooper, & Liang Zhong, COPPAcalypse? The YouTube Settlement’s Impact on Kids Content, SSRN (Apr. 26, 2023), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4430334.

[58] Id. at 6-7 (emphasis added).

[59] Id. at 1.

[60] FTC, supra note 56.

[61] Id. at 6 (emphasis added).

[62] See Michael Munger, To Consumers, All Costs are Transaction Costs, Am. Inst. Econ. Rsch. (June 13, 2023), https://www.aier.org/article/to-consumers-all-costs-are-transaction-costs.

[63] See Katie Robertson, Meta Begins Blocking News in Canada, N.Y. Times (Aug. 2, 2023), https://www.nytimes.com/2023/08/02/business/media/meta-news-in-canada.html; Mark Collom, Australia Made a Deal to Keep News on Facebook. Why Couldn’t Canada?, CBC News (Aug. 3, 2023), https://www.cbc.ca/news/world/meta-australia-google-news-canada-1.6925726.

[64] See id.

[65] Free Speech Coal. Inc. v. Colmenero, No. 1:23-CV-917-DAE, 2023 U.S. Dist. LEXIS 154065 (W.D. Tex. 2023), available at https://storage.courtlistener.com/recap/gov.uscourts.txwd.1172751222/gov.uscourts.txwd.1172751222.36.0.pdf.

[66] Id. at 10.

[67] Id.

[68] Id.

[69] Id. at 44.

[70] Geoffrey A. Manne, Ben Sperry, & Kristian Stout, Who Moderates the Moderators?: A Law & Economics Approach to Holding Online Platforms Accountable Without Destroying the Internet, 49 Rutgers Comput. & Tech. L.J. 26 (2022), https://laweconcenter.org/resources/who-moderates-the-moderators-a-law-economics-approach-to-holding-online-platforms-accountable-without-destroying-the-internet; Geoffrey A. Manne, Kristian Stout, & Ben Sperry, Twitter v. Taamneh and the Law & Economics of Intermediary Liability, Truth on the Market (Mar. 8, 2023), https://truthonthemarket.com/2023/03/08/twitter-v-taamneh-and-the-law-economics-of-intermediary-liability; Ben Sperry, The Law & Economics of Children’s Online Safety: The First Amendment and Online Intermediary Liability, Truth on the Market (May 12 2023), https://truthonthemarket.com/2023/05/12/the-law-economics-of-childrens-online-safety-the-first-amendment-and-online-intermediary-liability.

[71] See Manne, Stout, & Sperry, Twitter v. Taamneh and the Law & Economics of Intermediary Liability, supra note 70; Ben Sperry, Right to Anonymous Speech, Part 2: A Law & Economics Approach, Truth on the Market. (Sep. 6, 2023), httsps://truthonthemarket.com/2023/09/06/right-to-anonymous-speech-part-2-a-law-economics-approach; Manne, Sperry, & Stout, Who Moderates the Moderators?: A Law & Economics Approach to Holding Online Platforms Accountable Without Destroying the Internet, supra note 70.

[72] See Manne, Stout, & Sperry, Who Moderates the Moderators?: A Law & Economics Approach to Holding Online Platforms Accountable Without Destroying the Internet, supra note 70, at 28 (“To the extent that the current legal regime permits social harms online that exceed concomitant benefits, it should be reformed to deter those harms, provided it can be done so at sufficiently low cost.”); Sperry, Right to Anonymous Speech, Part 2: A Law & Economics Approach, supra note 71.

[73] See NetChoice Complaint, NetChoice LLC v. Griffin, NO. 5:23-CV-05105, available at 2023 U.S. Dist. LEXIS 154571 (W.D. Ark. 2023), https://netchoice.org/wp-content/uploads/2023/06/NetChoice-v-Griffin_-Complaint_2023-06-29.pdf.

[74] Id. at para. 13.

[75] See id. at para. 14

[76] See id.

[77] See id. at para 15.

[78] See id. at para 16.

[79] See id.

[80] See id. at para. 17, 19-21

[81] See Ben Sperry, Congress Should Focus on Protecting Teens from Real Harms, Not Targeted Ads, The Hill (Feb. 12, 2023), https://thehill.com/opinion/congress-blog/3862238-congress-should-focus-on-protecting-teens-from-real-harms-not-targeted-ads.

[82] See NetChoice Complaint, supra note 73 at para. 18.

[83] Government Response to the Roadmap for Age Verification, Australian Gov’t Dep’t of Infrastructure, Transp., Reg’l Dev., Commc’ns and the Arts (Aug. 2023), available at https://www.infrastructure.gov.au/sites/default/files/documents/government-response-to-the-roadmap-for-age-verification-august2023.pdf.

[84] See Josh Taylor, Australia Will Not Force Adult Websites to Bring in Age Verification Due To Privacy And Security Concerns, The Guardian (Aug. 30, 2023), https://www.theguardian.com/australia-news/2023/aug/31/roadmap-for-age-verification-online-pornographic-material-adult-websites-australia-law.

[85] See NetChoice Complaint, supra note 73 at 2.

[86] Id. at 6.

[87] See id.

[88] See id. at 6-8.

[89] Supra Part IV.A.

[90] See Children and Teen’s Online Privacy Protection Act, S. 1418, 118^th Cong. (2023), as amended Jul. 27, 2023, available at https://www.congress.gov/bill/118th-congress/senate-bill/1418/text (last accessed Oct. 2, 2023). Other similar bills have been proposed as well. See Protecting Kids on Social Media Act, S. 1291, 118th Cong. (2023); Making Age-Verification Technology Uniform, Robust, and Effective Act, S. 419, 118th Cong. (2023); Social Media Child Protection Act, H.R. 821, 118th Cong. (2023).

[91] See David Neumark & Peter Shirley, Myth or Measurement: What Does the New Minimum Wage Research Say About Minimum Wages and Job Loss in the United States? (Nat’l Bur. Econ. Res. Working Paper 28388, Mar. 2022), available at https://www.nber.org/papers/w28388 (concluding that “(i) there is a clear preponderance of negative estimates in the literature; (ii) this evidence is stronger for teens and young adults as well as the less-educated; (iii) the evidence from studies of directly-affected workers points even more strongly to negative employment effects; and (iv) the evidence from studies of low-wage industries is less one-sided.”).

[92] See Lisa Sturtevant, The Impacts of Rent Control: A Research Review and Synthesis, at 6-7, Nat’l Multifamily Hous. Coun’cl Res. Found. (May 2018), available at https://www.nmhc.org/globalassets/knowledge-library/rent-control-literature-review-final2.pdf (“1. Rent control and rent stabilization policies do a poor job at targeting benefits. While some low-income families do benefit from rent control, so, too, do higher-income households. There are more efficient and effective ways to provide assistance to lower-income individuals and families who have trouble finding housing they can afford. 2. Residents of rent-controlled units move less often than do residents of uncontrolled housing units, which can mean that rent control causes renters to continue to live in units that are too small, too large or not in the right locations to best meet their housing needs. 3. Rent-controlled buildings potentially can suffer from deterioration or lack of investment, but the risk is minimized when there are effective local requirements and/or incentives for building maintenance and improvements. 4. Rent control and rent stabilization laws lead to a reduction in the available supply of rental housing in a community, particularly through the conversion to ownership of controlled buildings. 5. Rent control policies can hold rents of controlled units at lower levels but not under all circumstances. 6. Rent control policies generally lead to higher rents in the uncontrolled market, with rents sometimes substantially higher than would be expected without rent control. 7. There are significant fiscal costs associated with implementing a rent control program.”).

[93] See Candeub, supra note 16.

[94] Colmenero, supra note 65, at 22.

[95] See Kids Online Safety Act, S. 1409, 118th Cong. (2023), as amended and posted by the Senate Committee on Commerce, Science , and Transportation on July 27, 2023, available at https://www.congress.gov/bill/118th-congress/senate-bill/1409/text#toc-id6fefcf1d-a1ae-4949-a826-23c1e1b1ef26 (last accessed Oct. 2, 2023).

[96] See id. at Section 3.

[97] Cf. Manhattan Community Access Corp. v. Halleck, 139 S. Ct. 1921, 1930-31 (2019):

[M]erely hosting speech by others is not a traditional, exclusive public function and does not alone transform private entities into state actors subject to First Amendment constraints…

If the rule were otherwise, all private property owners and private lessees who open their property for speech would be subject to First Amendment constraints and would lose the ability to exercise what they deem to be appropriate editorial discretion within that open forum. Private property owners and private lessees would face the unappetizing choice of allowing all comers or closing the platform altogether.

[98] See Counterman v. Colorado, 600 U.S. 66 (2023); Ben Sperry (@RBenSperry), Twitter (June 28, 2023, 4:46 PM), https://twitter.com/RBenSperry/status/1674157227387547648.

[99] Cf. HØEG v. Newsom, 2023 WL 414258 (E.D. Cal. Jan. 25, 2023); Sperry, The Law & Economics of Children’s Online Safety: The First Amendment and Online Intermediary Liability, supra note 70.

[100] California Age-Appropriate Design Code Act, AB 2273 (2022), https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=202120220AB2273.

[101] See id. at § 1798.99.32(d)(1), (2), (4).

[102] See Candeub, supra note 16.

[103] NetChoice LLC. v. Griffin, Case No. 5:23-CV-05105 at 25 (Aug. 31, 2023), slip op., available at https://netchoice.org/wp-content/uploads/2023/08/GRIFFIN-NETCHOICE-GRANTED.pdf.

[104] Id.

[105] Id. at 38 (“Having considered both sides’ positions on the level of constitutional scrutiny to be applied, the Court tends to agree with NetChoice that the restrictions in Act 689 are subject to strict scrutiny. However, the Court will not reach that conclusion definitively at this early stage in the proceedings and instead will apply intermediate scrutiny, as the State suggests.”).

[106] Id. at 48 (“In sum, NetChoice is likely to succeed on the merits of the First Amendment claim it raises on behalf of Arkansas users of member platforms. The State’s solution to the very real problems associated with minors’ time spent online and access to harmful content on social media is not narrowly tailored. Act 689 is likely to unduly burden adult and minor access to constitutionally protected speech. If the legislature’s goal in passing Act 689 was to protect minors from materials or interactions that could harm them online, there is no compelling evidence that the Act will be effective in achieving those goals.”).

[107] See NetChoice v. Bonta, Case No. 22-cv-08861-BLF (N.D. Cal. Sept. 18, 2023), slip op., available at https://netchoice.org/wp-content/uploads/2023/09/NETCHOICE-v-BONTA-PRELIMINARY-INJUNCTION-GRANTED.pdf; Ben Sperry, What Does NetChoice v. Bonta Mean for KOSA and Other Attempts to Protect Children Online?, Truth on the Market (Sep. 29, 2023), https://truthonthemarket.com/2023/09/29/what-does-netchoice-v-bonta-mean-for-kosa-and-other-attempts-to-protect-children-online.

[108] Id. at 36-38.

[109] See Carl Szabo, NetChoice Sends Veto Request to Utah Gov. Spencer Cox on HB 311 and SB 152, NetChoice (Mar. 3, 2023),  https://netchoice.org/netchoice-sends-veto-request-to-utah-gov-spencer-cox-on-hb-311-and-sb-153.

[110] See, e.g., Sable Commcn’s v. FCC, 492 U.S. 115, 126 (1989) (“The Government may, however, regulate the content of constitutionally protected speech in order to promote a compelling interest if it chooses the least restrictive means to further the articulated interest.”).

[111] Brown, 564 U.S. at 801 (“California claims that the Act is justified in aid of parental authority: By requiring that the purchase of violent video games can be made only by adults, the Act ensures that parents can decide what games are appropriate. At the outset, we note our doubts that punishing third parties for conveying protected speech to children just in case their parents disapprove of that speech is a proper governmental means of aiding parental authority.”).

[112] Brown, 564 U.S. at 801.

[113] Id. at 803

[114] Id.

[115] See supra IV.B.

[116] See Clare Morrell, Adam Candeub, & Michael Toscano, No, Big Tech Doesn’t Have A Right To Speak To Kids Without Their Parent’s Consent, The Federalist (Sept. 21, 2023), https://thefederalist.com/2023/09/21/no-big-tech-doesnt-have-a-right-to-speak-to-kids-without-their-parents-consent (noting “Justice Clarence Thomas wrote in his dissent in the Brown case that “the ‘freedom of speech,’ as originally understood, does not include a right to speak to minors (or a right of minors to access speech) without going through the minors’ parents or guardians.”).

[117] Brown, 564 U.S. at 821.

[118] Id. at 822.

[119] Id. at 805.

[120] Id. at 813.

[121] See, e.g., Ben Sperry, There’s Nothing ‘Conservative’ About Trump’s Views on Free Speech and the Regulation of Social Media, Truth on the Market (Jul. 12, 2019), https://truthonthemarket.com/2019/07/12/theres-nothing-conservative-about-trumps-views-on-free-speech (noting Kavanaugh’s majority opinion in Halleck on compelled speech included all the conservative justices; at the time he and Gorsuch were relatively new Trump appointees); Justice Amy Comey Barrett has also joined the majority opinion in 303 Creative LLC v. Elenis, 600 U.S. 570 (2023), written by Gorsuch and joined by all the conservatives, which found public-accommodations laws are subject to strict scrutiny if they implicate expressive activity.

[122] Clare Morell (@ClareMorellEPPC), Twitter (Sept. 7, 2023, 8:27 PM), https://twitter.com/ClareMorellEPPC/status/1699942446711357731.

[123] Brown, 564 U.S. at 786.

We thank the International Trade Administration (ITA), the National Institute of Standards and Technology (NIST) and the U.S. Patent and Trademark Office (USPTO) for this opportunity to comment on its call for evidence concerning a new framework for standard-essential patents.[1] The International Center for Law and Economics (ICLE) is a nonprofit, nonpartisan research center whose work promotes the use of law & economics methodologies to inform public-policy debates. We believe that intellectually rigorous, data-driven analysis will lead to efficient policy solutions that promote consumer welfare and global economic growth. ICLE’s scholars have written extensively on competition, intellectual property, and consumer-protection policy.

In this comment, we express concerns about global regulatory developments in the standard-essential patent (SEP) industry. The European Union is in the process of considering legislation that would fundamentally alter the landscape of global standards setting, making it more difficult for inventors to enforce their intellectual-property rights.[2] Not only will this legislation have profound ramifications for companies located all over the globe but—as the USPTO’s call for comments recognizes—the EU risks kicking off a global race to the bottom in regulating SEPs that will ultimately harm innovation and slow the diffusion of groundbreaking technologies.

We are concerned that a tit-for-tat response intended to counteract bad policies in the EU (and among other allied nations) is doomed to do more harm than good. Erecting what amount to protectionist barriers—even if in response to similar regulations abroad—would diminish U.S. interests, as well as those of our partners. Instead, the agencies should be seeking opportunities to influence the policy decisions made in foreign jurisdictions, in the hope that those entities will pursue better policies.

For obvious reasons, the way intellectual-property disputes are resolved has tremendous ramifications for firms that operate in standard-reliant industries. Not only do many of the firms in this space derive a large share of their revenue from patents but, perhaps more importantly, the prospect of litigation dictates how firms structure the transfer of intellectual-property assets. In simple terms, ineffectual judicial remedies for IP infringements and uncertainty concerning the resolution of IP disputes discourage firms from concluding license agreements in the first place.

The key role that IP plays in these industries should impel policymakers to proceed with caution. By virtually all available metrics, the current system works. The development of innovative technologies through standards development organizations (SDOs) has led to the emergence of some of the most groundbreaking technologies that consumers use today;[3] and recent empirical evidence suggests that many of the alleged ills that have been associated with the overenforcement of intellectual-property rights simply fail to materialize in industries that rely on standard-essential patents.[4]

At the same time, “there is no empirical evidence of structural and systematic problems of holdup and royalty stacking affecting standard-essential patent (“SEP”) licensing.”[5] Indeed, “[t]he notion that implementers in such innovation–driven industries are being suffocated by an insurmountable patent royalty stack has turned out to be nothing more than horror fiction.”[6] Yet, without a sound basis, the anti-injunctions approach increasingly espoused by policymakers unnecessarily “adds a layer of additional legal complexity and alters bargaining processes, unduly favoring implementers.”[7]

Licensing negotiations involving complex technologies are legally intricate. It is simply not helpful for a regulatory body to impose a particular vision of licensing negotiations if the goal is more innovation and greater ultimate returns to consumers. Instead, where possible, policy should prefer allowing parties to negotiate at arm’s length and to resolve disputes through courts. In addition to maintaining the sometimes-necessary remedy of injunctive relief against bad-faith implementers, this approach allows courts to explore when injunctive relief is appropriate on a case-by-case basis. Thus, over the course of examining actual cases, courts can refine the standards that determine when an injunctive remedy is inappropriate. Indeed, the very exercise of designing ex ante rules and guidelines to inform F/RAND licensing is antagonistic to optimal policymaking, as judges are far better situated and equipped to make the necessary marginal adjustments to the system.

Against this backdrop, our comments highlight several factors that should counsel preserving the rules that currently govern SEP-licensing agreements:

To start, the SEP space is far more complex than many recognize. Critics often assume that collaborative standards development creates significant scope for opportunistic behavior—notably, patent holdup. The tremendous growth of SEP-reliant industries and market participants’ strong preference for this form of technological development, however, suggest these problems are nowhere near as widespread as many believe.

Second, it is important not to overlook the important benefits conferred by existing IP protections. This includes the advantages inherent in pursuing injunctions rather than damages awards.

Third, weakening the protections afforded to SEP holders would also erode the West’s technological leadership over economies that are heavily reliant on manufacturing, and whose policymakers routinely undermine foreign firms’ intellectual-property rights. In short, while IP promotes innovation, weakened patent protection has second-order effects that are often overlooked, such as ceding advantages to China’s manufacturing sector and thereby exacerbating U.S.-China tensions.

Fourth, while mandated transparency in SEP negotiations may appear beneficial, the reality is more complex, as disclosure requirements can have mixed effects. Further, transparency mandates would likely require government interventions, such as essentiality checks, which can be very costly.

Finally, collective SEP rate-setting raises antitrust issues that stem from firms’ need to share sensitive data in order to determine a standard’s value. Vertically integrated SEP holders setting collective royalties on the inputs they manufacture could enable price-fixing and collusion. Safeguards like third-party mediation in patent pools may be needed so that joint SEP rate negotiation does not violate antitrust rules barring competitors from fixing prices.

I.        Regulatory Developments in Foreign Jurisdictions

In their call for comments, the agencies essentially ask whether regulatory developments in foreign jurisdictions threaten U.S. technological leadership in industries that rely on standard-essential patents and, if so, how the United States should respond:

Do the intellectual property rights policies of foreign jurisdictions threaten any of U.S. leadership in international standard setting, U.S. participation in international standard setting, and/or the growth of U.S. SMEs that rely on the ability to readily license standard essential patents?

If responding affirmatively to question 1, what can the Department of Commerce do to mitigate the effects of any adverse foreign policies relating to intellectual property rights and standards? Please clearly identify any such adverse foreign policies with specificity.[8]

Recent regulatory developments in the European Union loom large over the agencies’ two questions. On April 27, the European Commission published its Proposal for a Regulation on Standard Essential Patents (“SEP Regulation”). The SEP Regulation’s proclaimed aims are to ensure that end users—including small businesses and EU consumers—benefit from products based on the latest standardized technologies; make the EU attractive for standards innovation; and encourage both SEP holders and implementers to innovate in the EU, make and sell products in the EU, and be competitive in non-EU markets.[9]

While we share the agencies’ concern, responding to this foreign legislation (and other international responses that are likely to arise) by enacting similar policies would only exacerbate the situation and further erode U.S. technological leadership. In fact, several of the EU legislation’s shortcomings that would be rendered more destructive if the United States responded in kind.

As ICLE-affiliated scholars have explained in comments on the draft European legislation,[10]  the available evidence does not support a finding of market failure in SEP-licensing markets that would justify intrusive regulatory oversight. Instead, the Commission’s own evidence points to the low incidence of SEP litigation and no systemic negative effects on SEP owners and implementers. The mobile-telecommunication market, which is claimed to have the most SEP litigation and licensing inefficiencies, has over the years seen rapid growth, expansion, declining consumer prices, and new market entry.

Some market imperfections are necessary-but-not-sufficient conditions for regulatory intervention. Regulation might not be necessary or proportionate if its aims could be achieved with less costly instruments.

The EU’s proposed SEP Regulation appears to pursue the value-redistributive function of imposing costs on only one group (SEP owners), while accruing all benefits to non-EU (or US)-based standard implementers. It is difficult to find justification for such value redistribution from the evidence presented on the functioning of SEP licensing markets.

The proposed EU SEP Regulation applies to all standards licensed on FRAND terms. It is unclear how many standards would be caught and why all standards licensed on FRAND terms are presumed to be inefficient, requiring regulatory intervention. One early study identified 148 standards licensed on FRAND terms in a 2010 laptop. No evidence was presented that licensing inefficiencies of these standards caused harms in laptop markets.

The EU legislation would require evaluators and conciliators that need to be qualified and experienced experts in relevant fields. There are unlikely to be enough evaluators to conduct essentiality checks reliably on such a massive scale.

To make matters worse, the proposed SEP Regulation raises competition concerns, as it requires SEP owners to agree on global aggregate royalty rates. No safeguards are provided against the exchange of sensitive commercial information and possible cartelization.

There is also a risk that legislation seeking to make the standardization space more transparent, by mandating aggregate royalty-rate notifications and nonbinding expert opinions on global aggregate royalty rates, may lead to even more confusion for implementers.

Finally, the EU’s proposed SEP Regulation would have extraterritorial effects. Indeed, while the SEP Register and system of “essentiality checks” created by the regulation would apply only for patents in force in EU Member States, its system of nonbinding opinions on aggregate royalties and FRAND determination would apply worldwide, covering portfolios in other countries. Other countries—including the United States—may follow suit and introduce their own regulations on SEPs. Such regulations may be used as a strategic and protectionist tool to devaluate the royalties of innovative SEP owners. The proliferation of regulatory regimes would make SEP licensing even more costly, with unknown effects on the viability of the current system of collaborative and open standardization.

Considering the above, it would appear unwise for the United States to mimic the EU’s draft SEP regulation. In its current form, the regulation is likely to harm both U.S. and European innovators. In turn, this threatens the west’s technological leadership on a global stage and will serve the interests of jurisdictions whose economies rely heavily on implementing standard-essential technologies and that generally have weaker IP protection than either the United States or the EU.

Instead, the agencies should look for opportunities to work with their foreign counterparts to improve the proposed EU legislation (and other similar measures in other jurisdictions). Neither EU nor U.S. interests will be well-served by these sorts of regulatory endeavors, least of all if both areas enact ill-advised SEP policies. Sound policy should be focused on ensuring that the successful SEP ecosystem continues to perform as impressively as it has to date. Enacting defensive measures against the EU legislation will create a tit-for-tat dynamic that will double the obstacles faced by innovators in both the EU and the United States, allowing foreign rivals to take advantage of the situation.

II.      Regulatory Restraint

In their call for comments, the agencies ask what private entities can do to boost America’s participation in international standard-setting efforts:

What more can other entities do, such as standards development organizations, industry or consumer associations, academia, or U.S. businesses to help improve American leadership, participation in international standard setting, and/or increased participation of small to medium-sized enterprises that rely on the ability to readily license standard essential patents?[11]

While this is a good way to look at the issue (today’s standardization practices were born of spontaneous market interactions, rather than government fiat, which leaves private entities with a clearly significant role to play in this space), one should not overestimate the extent to which governments can identify inefficiencies that may afflict standard-reliant industries and nudge private parties to resolve them—e.g., by asking SDOs to curb the use of injunctions or encourage collective royalty-setting agreements.

It’s tempting for lawmakers to look at the complex SEP licensing process as a Gordian Knot to be solved through regulatory fiat. But pursuing Alexander’s solution, though expedient, would similarly leave the SEP licensing ecosystem in tatters.

Consider smartphones: Tens of thousands of patents are essential to making smartphone technology work.^[12] Some critics posit that this makes it extremely difficult to market smartphones effectively, but no evidence supports this claim, and the proliferation of smartphones suggests otherwise.[13] It is worth considering that cellphone technology marks the culmination of research efforts spanning the entire globe. The coordinated efforts of these numerous firms are not the result of government coercion, but the free play of competitive forces.

Coordination on such a vast scale is no simple task. And yet, of the vast array of options available to them, an increasing number of firms have settled on one particular paradigm to solve these coordination problems: the development of new technologies and open standards within SDOs. These organizations and their members are responsible not only for wireless cellular technologies (e.g., 3G, 4G, 5G) but also for such high-profile technologies as Wi-Fi, USB, and Blu-ray, among many others.[14]

Throughout history, economic actors have sought to reap the benefits of specialization and interoperability. This has led to the emergence of various standardization practices, ranging from de facto standards and competition for the market, to complex standard-setting procedures within SDOs.

Ultimately, because interoperability standards rely on firms being able to coordinate their behavior, standardization necessarily implies a degree of incentive compatibility. That is, parties will coordinate their behavior only if they expect that doing so will be mutually beneficial. “This mutuality of considerations has been at the heart of the voluntary FRAND bargain from the outset, given that any risks of holdup or misappropriation of information are bilateral—that is, such risks work in both directions.”[15] This implies that SDOs must design balanced internal rules that bring both patent holders and implementers to the table through mutually agreeable interoperability standards, and guarantee that they will continue to work together into the future as new technologies emerge.[16]

Establishment of SDO interoperability standards typically follows a process by which interested parties come together and identify technological problems that they might be able to solve cooperatively.^[17] SDO members include a wide range of stakeholders, including (among others): companies that manufacture products implementing the technology, companies that market services that use the standards, companies that operate networks that practice the standards, technology firms that create technologies that are included in the standards, academic institutions, and government agencies.[18]

The SDO provides information to interested parties about the standard-setting project and a forum for collaboration.[19] Members attend standard-setting meetings, vote on standardization decisions, and make technological contributions. Participation in standard setting can be subject to a substantial fee and always entails considerable time. There are policies and procedures (“bylaws”) that govern the process of adoption and standard development. Participation in SDOs is voluntary and is subject to acceptance of the terms and conditions set out in the bylaws. These aim to allow the most appropriate technology to become standardized, based on several factors. This is a democratic and consensus-based process designed to ensure that no single participant can manipulate it. Many SDOs also allow for post-adoption appeals by dissenting members. This ultimately leads to a series of technical specifications upon which implementers can build products.

Throughout this process, a critical challenge for SDOs is to ensure that their internal regulations remain “incentive compatible.” To optimize their technological output and ensure the success of their standards, SDOs must attract the right mix of both implementers and innovators. “Most succinctly, the ‘right membership’ comprises a significant portion of each class of stakeholder whose active support is needed to achieve broad adoption.”[20] They thus need to design internal procedures that strike a balance between the sometimes-diverging interests of these stakeholders.

This is no simple task. Although there are numerous ways in which these rules may favor a particular group of participants, allocating the profits of standardization is perhaps the most salient. To a first approximation, SEP holders will tend to favor internal rules that allow them to charge prices that are close to the monopoly benchmark (though not the double-marginalization one). Conversely, implementers will generally prefer policies that limit SEP holders’ returns (so long as this does not dry up the supply of inventions). However, these first-order incentives may not always hold true in the real world. Practical considerations may, for instance, urge SEP holders to accept a pricing structure that is not “profit maximizing” in the short run, but which may incentivize further cooperation or the adoption of an underlying technology.^[21]

The above has important consequences for patent and antitrust policy in SEP-reliant industries. As we have explained, collaborative standard development gives rise to complex incentives, as well as a web of heterogeneous and deliberately incomplete contracts (i.e., where the parties choose not to specify some aspects of their agreement).[22] Given this diversity, uniform and centralized policies that needlessly constrain the range of negotiation—such as a federal-enforcement presumption against injunctions—would likely lead to fewer agreements and inefficient outcomes in numerous cases, especially compared to case-by-case adjudication of F/RAND commitments under the common law of contract.[23]

In short, “standards organizations and market participants are better than regulators at balancing the interests of patent holders and implementers.”[24] Interfering with the emergent norms of the standard-development industry thus risks undermining innovators’ expectations of a reasonable return on their investments:

Each of the innovative companies that agrees to be an SSO participant does so with the understanding of the investments they have made in research, development, and participation, as well as the risks that their innovations may not be selected for incorporation in the standard. They bear these investments and risk with the further understanding that they will receive adequate and fair remuneration as part of the FRAND commitment they have made to the SSO.

Unfortunately, the actions of the courts and the proposals by commentators are greatly undermining the value and benefits of SSO participation that are expected….[25]

III.    The Importance of Injunctions

The agencies’ call for comments appears concerned that current standardization practices may be hindering U.S. innovation and the creation of startups in the SEP space:

Are current fair, reasonable, and non-discriminatory (FRAND) licensing practices adequate to sustain U.S. innovation and global competitiveness? Are there other international models which would better serve U.S. innovation in the future?

Are there specific U.S. intellectual property laws or policies that inhibit participation in standards development?

Are there specific U.S. intellectual property laws or policies that inhibit growth of SMEs that rely on licensing and implementing standards? [26]

While they are not mentioned explicitly in the agencies’ call for comments, the role of injunctions sought against implementers by SEP holders looms large over the above questions. The use of injunctions is arguably one of the most contentious—and widely misunderstood—topics in SEP policy debates. While often portrayed as a means for inventors to extract unreasonable royalties from helpless implementors injunctions are, in fact, a critical legal tool that encourages all parties in the standardization space to come to the negotiation table. In fact, even the EU’s draft regulation on SEPs—which in many other respects reduces the protections afforded to inventors—implicitly recognizes the crucial role that injunctions play, by ensuring that the various proposed SEP transparency and arbitration procedures do not undermine parties’ ability to obtain an injunction:

The obligation to initiate FRAND determination should not be detrimental to the effective protection of the parties’ rights. In that respect, the party that commits to comply with the outcome of the FRAND determination while the other party fails to do so should be entitled to initiate proceedings before the competent national court pending the FRAND determination. In addition, either party should be able to request a provisional injunction of a financial nature before the competent court.[27]

A.   The Fundamental Value of Injunctions

Historically, one of the most important features of property rights in general, and patents in particular, is that they provide owners with the power to exclude unauthorized use by third parties and thus enable them to negotiate over the terms on which instances of use or sale will be authorized.^[28] While the ability to exclude is important in creating the incentive to innovate, it is equally—and perhaps more—important in facilitating the licensing of inventions.^[29]

There are many reasons that someone may invent a new product or process. But if they are to be optimally encouraged to distribute that product and thus generate the associated social welfare, it is crucial that they retain the ability to engage supply chains to commercialize the invention fully.^[30] “[T]he patent system encourages and enables not just invention but also innovation by providing the basic, enforceable property rights that facilitate (theoretically) efficient organizations of economic resources and the negotiations necessary to coordinate production among them.”[31] If a patent holder believes that the path to commercialization and remuneration is hindered by infringers, she will have less incentive to invest fully in the commercialization process (or in the innovation in the first place).

Removing the injunction option… not only changes the bargaining range (and makes infringement a valid business option), but, by extension, it lowers the expected returns of investing in the creation and commercialization of patents, in the first place…. With a no-injunction presumption…, as long as the expected cost of litigation is less than the expected gain from infringing without paying any royalties, potential licensees will always have an incentive to pursue this strategy. The net result is a shift in bargaining power so that, even when license agreements are struck, royalty rates are lower than they would otherwise be, as well as an increased likelihood of infringement.[32]

Because infringement affects both the initial incentive to innovate as well as the complex process of commercialization, courts have historically granted injunctions against those who have used a patent without proper authorization.

B.   Damages Alone Are Often Insufficient

Injunctions are almost certainly the most powerful means to enforce property rights and remedy breaches. Nonetheless, courts may sometimes award damages, either in addition to or as an alternative to awarding an injunction.^[33] It is often difficult to establish the appropriate size of an award of damages, however, when intangible property—such as invention and innovation, in the case of patents—is the core property being protected.

In this respect, a key feature of patents is that they possess uncertain value ex ante. The value of a particular invention or discovery cannot be known until it is either integrated into the end-product that will be distributed to consumers, or actually used by consumers.[34] This massive upfront uncertainty creates the need for technology designers to carefully structure their investments such that the risk/reward ratio remains sufficiently low. This, in turn, means ensuring that their inventions’ commercialization can reasonably be expected to generate sufficient profits.

Commercializing highly complex innovations, such as pharmaceuticals and advanced technologies, requires a large degree of risk taking and capital investment, as well as massive foregone opportunities. As such, it will often be difficult, or even impossible, to adequately calculate appropriate monetary damages for the unauthorized use of a patent, even if the patent’s ex post value is knowable. Put differently, the inability to bargain effectively for royalties post-standardization may “deter investment… and ultimately harm consumers.”[35]

While it is necessary to establish damages for violations after the fact, it will nearly always be appropriate to award injunctions to deter ongoing violations. This would further allow the property owner to do their own value calculations, based on their investments, sunk costs, and—critically—lost opportunities that were foregone in order to realize the particular invention. “[A] property rule is superior to a liability rule when ‘the court lacks information about both damages and benefits.’ Without accurate information, the damages may be set below the actual level of harm, encouraging the ‘injurer’ (or infringer) to engage in an excessive level of activity—in our case, increased infringement.”[36]

C.   Injunctions Encourage Efficient Licensing Negotiations

In addition to the concerns outlined in the previous section, it is worth noting that curbs on injunctions pertaining to SEPs would make inventors bear the risk of opportunistic behavior, thus enabling  firms to opt out of commercial negotiations and wait for potential litigation. In turn, this would tilt the bargaining scale in their favor in subsequent royalty negotiations undertaken in the shadow of prior court proceedings.[37]

The U.S. Supreme Court’s 2006 decision in eBay v. MercExchange offers a case in point. The court rejected the “general rule” that a prevailing patentee is entitled to an injunction.[38] In the aftermath of the decision, courts refused to grant injunctions in considerably more cases.[39]

Nearly two decades later, however, questions remain regarding eBay’s effect on patent licensing, negotiation, and litigation.[40] In particular, it is likely that eBay systematically distorted the relative bargaining positions in SEP licensing in favor of implementers, at the expense of patent holders. One post-eBay assessment argues that limiting injunctions to prevent holdup results in more “false positives”—where patent holders with no designs of patent holdup are nonetheless denied injunctive relief—than it does deterrence of actual holdups.[41] The result is a reduction in the cost of willful infringement and “under-compensation” for innovation.[42]

One of the important features of injunctions that critics miss is that they are not solely a tool for simple exclusion from property, but a tool that promotes efficient bargaining.[43] If a property holder ultimately has the right to exclude infringers, there is relatively more weight placed on the importance of initial bargaining for licenses. “It is the very threat of the injunction right—and its associated high transaction costs—that brings the parties to the negotiating table and motivates them to draw upon the full scope of their knowledge and creativity in forming contractual and institutional solutions to the perceived holdup problem.”[44]

Post-eBay, “efficient infringement” becomes a viable choice for firms seeking to maximize profits. Thus, implementing firms seeking to pay as little as possible for use of an invention have incentive to disregard the bargaining process with a patent holder altogether. The relative decline in the importance of injunctions narrows the bargaining range. The narrower range of prices that an implementing firm will offer means that, even where it does bargain, agreement will be less likely. Where rightsholders can be reasonably expected to enforce their patent rights, by contrast, the bargaining range is expanded and agreement is more likely, because the initial cost of negotiating for a license is relatively less than always (or usually) opting for “efficient infringement”; that is, infringement becomes less efficient.

The ultimate tension is not between seeking damages or an injunction, but between whether a firm opts to negotiate or to litigate, while facing the risk of some combination of damages and injunction on the back end.

This reality is particularly important in the context of SDOs, where implementers and innovators are in a constant dance both to maximize their own profits as well as to facilitate the product of an incomplete, joint agreement that binds each party. “The seminal example of intentional contractual incompleteness is the F/RAND commitment common in many [SDO’s] IPR policies.”[45] Permitting one party, through weakened legal doctrine, to circumvent or artificially constrain the bargaining process inappropriately imbalances the careful commercial relationships that should otherwise exist.

In the SEP context, furthermore, it is rarely mentioned that “an implementer’s decision to reject a certifiably F/RAND license and continue to infringe is contrary to the spirit of the F/RAND framework as well.”^[46]

Moreover, it is not typically the case that a negotiation process would end with an injunction and a refusal to license, as critics sometimes allege. Rather, the threat of an injunction is important in hastening an infringing implementer to the table and ensuring that protracted litigation to determine the appropriate royalty (which is how such disputes do actually end) is costly not only to the patentee, but also to the infringer. As James Ratliff and Daniel Rubinfeld explain:

[T]he existence of that threat does not lead to holdup as feared by those who propose that a RAND pledge implies (or should embody) a waiver of seeking injunctive relief. If RAND terms are reached by negotiation, the negotiation is not conducted in the shadow of an injunctive threat but rather in the shadow of knowledge that the court will impose a set of terms if the parties do not reach agreement themselves. The crucial element of this model that substantially diminishes the likelihood that the injunctive threat will have real bite against an implementer willing to license on RAND terms is the assumption that an SEP owner maintains its obligation to offer a RAND license even if its initial offer is challenged by the implementer and, further, even if the court agrees with the SEP owner that its initial offer was indeed RAND. Thus any implementer that is willing to license on court-certified RAND terms can avoid an injunction by accepting those RAND terms without eschewing any of its challenges to the RAND-ness of the SEP owner’s earlier offers.[47]

Ultimately, this means that an implementer that accepts nominally F/RAND terms need not be an actual “willing licensee,” but instead can gain that designation as a matter of law without ever accepting a royalty rate within the true bargaining range that includes the licensor’s valid injunction threat. “[B]y stripping the SEP holder’s right to injunctive relief, [a no-injunction rule] may enable a potential licensee to delay good faith negotiation of a F/RAND license and the patent holder could be forced to accept less than fair market value for the use of the patent…. Undermining this bargaining outcome using antitrust rules runs a significant risk of doing more harm than good.”[48]

For the purposes of this proceeding, the lesson is clear: U.S. policy needs to return to a neutral position in which both parties in a F/RAND negotiation are encouraged to reach mutually agreeable terms in arm’s length licensing transactions. The effects of eBay and its progeny have distorted that bargaining process. Here, the agencies have an important role to play in pressing the need for this change.

IV.    Increased Transparency Is No Free Lunch

The agencies’ call for comments asks whether increased transparency requirements in the SEP space could make SEP licensing more efficient:

What can the Department of Commerce do to mitigate emergence or facilitate the resolution of FRAND licensing disputes? Can requiring further transparency concerning patent ownership make standard essential patent (SEP) licensing more efficient? What are other impediments to reaching a FRAND license that the Department of Commerce could address through policy or regulation?[49]

But while fostering transparency may appear to be a win-win proposition for all parties in the standardization space, the reality is far more complex. In many instances, inventors are already required to disclose their standard essential patents—and these requirements have ambiguous effects.[50] Given this, demands for further transparency would almost certainly entail some form of government intervention, such as the creation of SEP registers and government-run essentiality checks, which seek to verify whether the patents that firms declare as standard-essential are truly so.

Unfortunately, these attempts to make SEP-reliant industries more transparent are anything but costless. The EU’s draft SEP regulation offers a case in point. The regulation would create a system of government-run essentiality checks and nonbinding royalty arbitrations that seek to make the process easier for implementers. But as ICLE scholars have written, this scheme will prove extremely difficult and costly to operate in practice.[51] Much the same would be true of attempts to introduce similar measures in the United States.

The proposed EU regulation would rely on qualified experts to work as evaluators and conciliators. Evaluators will need specialized knowledge of the particular technological area in which they will conduct essentiality checks. The European Commission estimates that there are about 1,500 experts (650 patent attorneys and 800 patent examiners) qualified to do essentiality checks in the EU.[52]

The sheer magnitude of the task, however, will require many more evaluators and it is very doubtful that the optimal number of potential qualified experts are even available to join this process. For certain, special arrangements would need to be made with patent offices to grant patent examiners leave to conduct essentiality checks. Each year, evaluators would need to test a random sample of up to 100 SEPs if requested by each SEP owner or an implementer per standard. Thus, the amount of work may exponentially increase depending on how many standards are caught by the regulation.

If 148 FRAND-licensed standards per laptop are to serve as a rough proxy, then we might expect more than 100-200 standards to be checked for essentiality every year. In addition, if SEP owners and implementers regularly use the possibility of testing up to 100 SEPs per standard and per SEP owner, the sheer magnitude of work may exceed the capacity of patent attorneys. Patent attorneys may find it challenging to regularly engage in such high volumes of essentiality checks while also serving other clients. And why should they do it at all unless the rate of pay is at least what they could earn in a patent law firm? To be blunt, the work would not be as much fun as acting for real clients, so the pay would probably have to be even higher to attract applicants.

Consequently, it is very unlikely that the capability even exists to annually perform a large number of essentiality checks of registered SEPs. If the requirements to become an evaluator were relaxed to address this workload, this would cast doubt on the reliability of the whole system. There is no point in building a battleship unless you are sure you can get a competent crew.

Additionally, the patent attorneys most likely to be familiar with these technologies may well also find themselves with conflicts of interest. They will probably have worked for some SEP owners or implementers. Elaborate rules to avoid such conflicts would need to be implemented to prevent patent attorneys who were, or still are, engaged with certain clients from becoming evaluators of those clients’ registered SEPs. The conflicts problem would, of course, apply not just to individual attorneys but to their entire firms.

Conciliators would also need to be experts in the field. They might come from the ranks of retired judges, seasoned former company officials, or experienced lawyers. Conflict-of-interest provisions would also be needed to ensure their independence and impartiality in mandatory FRAND determinations.  But the job would, again, have to be sufficiently attractive, both in remuneration and in work content and culture. The Commission has made no investigation as to whether a sufficiently large pool of credible individuals could be found to make the system work.

Of course, there are well-established voluntary systems of conciliators and mediators, some of which are used now to help resolve FRAND disputes. But the proposal adds the idea of compulsory mediation or conciliation. There is scant evidence that either system works in other commercial disputes around the world, and it is unclear why it should be assumed to work here.

In short, it is doubtful that a government-operated scheme of essentiality checks and SEP-royalty arbitrations could reach satisfactory outcomes, as the expertise to do so is lacking and attracting potentially thousands of professionals from the private sector would be too costly. The result is that any government scheme along these lines is unlikely to have the necessary staffing to conduct its mission to the requisite standard. It would thus risk doing more harm than good.

V.      SEP Rights and China’s ‘Cyber Great Power’ Ambitions

In their call for comments, the agencies express a desire to protect the United States’ leading position in the field of standard development and implementation:

Are there steps that the Department of Commerce can take regarding intellectual property rights policy that will help advance U.S. leadership in standards development and implementation for critical and emerging technologies?[53]

The agencies essentially ask what active steps they could take to preserve the United States’ leading position. This, however, ignores the arguably more important question: What steps should the United States avoid taking? As we explain below, U.S. agencies should be particularly careful not to weaken intellectual-property protection in ways that may, ultimately, favor firms in other jurisdictions, such as China.

Observers often regard intellectual property as merely protecting original creations and inventions, thus boosting investments. But while IP certainly does this, it is important to look beyond this narrow framing. Indeed, by protecting these creations, intellectual-property protection—particularly that of patents—produces beneficial second-order effects in several important policy areas.

Consequently, weakening patent protection could have detrimental ramifications that are routinely overlooked by policymakers. This includes giving a leg up to jurisdictions that are heavily geared toward manufacturing, rather than  R&D, and specifically to  China (with knock-on effects for ongoing political tensions between these two superpowers).

As the USPTO has observed:

Innovation and creative endeavors are indispensable elements that drive economic growth and sustain the competitive edge of the U.S. economy. The last century recorded unprecedented improvements in the health, economic well-being, and overall quality of life for the entire U.S. population. As the world leader in innovation, U.S. companies have relied on intellectual property (IP) as one of the leading tools with which such advances were promoted and realized.[54]

The United States is a world leader in the production and commercialization of IP, and naturally seeks to retain that comparative advantage.[55] IP and its legal protections will become increasingly important if the United States is to maintain its prominence, especially when dealing with international jurisdictions, like China, that don’t offer similar levels of legal protection.[56] By making it harder for patent holders to obtain injunctions, licensees and implementers gain the advantage in the short term, because they are able to use patented technology without having to engage in negotiations to pay the full market price. In the case of many SEPs—particularly those in the telecommunications sector—a great many patent holders are U.S.-based, while the lion’s share of implementers are Chinese. Potential anti-injunction policies may thus amount to a subsidy to Chinese infringers of western technology.

At the same time, China routinely undermines western intellectual-property protections through its industrial policy. The government’s stated goal is to promote “fair and reasonable” international rules, but it is clear that China stretches its power over intellectual property around the world by granting “anti-suit injunctions” on behalf of Chinese smartphone makers, designed to curtail enforcement of foreign companies’ patent rights.[57]

In several recent cases, Chinese courts have claimed jurisdiction over F/RAND issues.[58] In Oppo v. Sharp, the Supreme People’s Court of China determined that Chinese courts can set the global terms of what is a fair and reasonable price for a license,[59] even if that award would be considerably lower than in other jurisdictions. This decision follows Huawei v. Conversant, in which a Chinese court for the first time claimed the ability to issue an anti-suit injunction against the Chinese company.[60]

All of this is part of the Chinese government’s larger approach to industrial policy, which seeks to expand Chinese power in international trade negotiations and in global standards bodies.[61] As one Chinese Communist Party official put it: “Standards are the commanding heights, the right to speak, and the right to control. Therefore, the one who obtains the standards gains the world.”[62] Chinese President Xi Jinping frequently (but only domestically) references China’s “cyber great power” ambitions: “We must accelerate the promotion of China’s international discourse power and rule-making power in cyberspace and make unremitting efforts towards the goal of building a cyber great power.”[63] Chinese leaders are intentionally pursuing a two-track strategy of taking over standards bodies and focusing on building platforms to create path dependencies that cause others to rely on Chinese technology.[64] As a Hinrich Foundation Report notes:

Trade and technical standards are inherently interrelated. They are mutually reinforcing. But Beijing treats standard setting, and standards organizations, as competitive domains. This approach risks distorting global trade. Beijing does not support a neutral architecture where iterative negotiating strives for technical interoperability. Instead, Beijing promotes an architecture that bolsters and cements Chinese competitiveness. Due to China’s size and centralization, the consequences of this approach will reverberate across the international system. Given the nature of emerging technology and standards, the consequences will endure.[65]

Insufficient protections for intellectual property will hasten China’s objective of dominating collaborative standard development in the medium- to long-term.[66] U.S. entrepreneurs are able to engage in the types of research and development that drive innovation because they can monetize those innovations. Reducing the returns for patents that eventually become standards will lead to less investment in those technologies. It will also harm the competitive position of American companies that refrain from collaborating because the benefits don’t outweigh the costs, including “missing the opportunity to steer a standard in the manner most compatible with a company’s product offerings, falling behind competitors, or failing to head off broad adoption of a second standard….”[67]

Simultaneously, this will engender a switch to greater reliance on proprietary, closed standards rather than collaborative, open standards. Proprietary standards (and competition among those standards) are sometimes the most efficient outcome: for instance, when the costs of interoperability outweigh the benefits. The same cannot be said, however, for government policies that effectively coerce firms into adopting proprietary standards by raising the relative costs of the collaborative standard-development process. In other words, there are social costs when firms are artificially prevented from taking part in collaborative standard setting and forced instead to opt for proprietary standards.

Yet this is precisely what will happen to U.S. firms if IP rights are not sufficiently enforceable. Indeed, as explained above, collaborative standardization is an important driver of growth.[68] It is crucial that governments do not needlessly undermine these benefits by preventing American firms from competing effectively in these international markets.

These harmful consequences are magnified in the context of the global technology landscape, and in light of China’s strategic effort to shape international technology standards.[69] With U.S. firms systematically deterred from participating in the development of open technology standards, Chinese companies, directed by their government authorities, will gain significant control of the technologies that will underpin tomorrow’s digital goods and services. The consequences are potentially catastrophic:

The effect of [China’s] approach goes far beyond competitive commercial advantage. The export of Chinese surveillance and censorship technology provides authoritarian governments with new tools of repression. Governments that seek to control their citizens’ access to the internet are supportive of Beijing’s “cyber sovereignty” paradigm, which can lead to a balkanized internet riddled with incompatibilities that impede international commerce and slow technological innovation. And when cyber sovereignty is paired with Beijing’s push to redefine human rights as the “collective” rights of society as defined by the state, authoritarian governments gain a shield of impunity for violations of universal norms.[70]

With Chinese authorities joining standardization bodies and increasingly claiming jurisdiction over F/RAND disputes, there should be careful reevaluation of the ways weakened IP protection would further hamper the U.S. position as  a leader in intellectual property and innovation.

To return to the framing question, yes, there are steps the agencies could take to secure and promote U.S. leadership in intellectual-property-intensive industries. The first step, as noted throughout this comment, is to refrain from promoting policies that unnecessarily imbalance the negotiation process between innovators and implementers. The second step is twofold. First, work with trustworthy partners, like the EU, to make sure that U.S. Allies’ IP policies are in alignment with and are geared  toward promoting neutral standards that allow tech industries to thrive. The second part is to advocate for trade policies that dissuade countries like China from using their domestic courts and regulatory agencies as protectionist entities designed simply to advance China’s national interests.

VI.    Competition Concerns with Aggregate Royalties

In the call for comments, the agencies ask:

Do policy solutions that would require SEP holders to agree collectively on rates or have parties rely on joint negotiation to reach FRAND license agreements with SEP holders create legal risks? Are there other concerns with these solutions?[71]

A host of competition concerns are implicated in this question, in that it requires SEP owners to negotiate and ultimately agree on aggregate royalty rates for standards.  This may require SEP owners to exchange sensitive commercial information relevant to establishing the value that devices derive from using the standardized technology. Competition-sensitive data could include projected revenues on a per-unit basis following the incorporation of connectivity in the end products, the number of end products sold on the market, actual and forecast sales, and price projections.[72] The competitive dangers inherent in this process are more serious for those vertically integrated SEP owners, who simultaneously hold SEPs and manufacture standard-implementing products. They would effectively agree to set the costs (royalties) for their inputs and exchange data about their downstream sales.

Jointly negotiated rates could therefore potentially run afoul of antitrust laws that prohibit companies from engaging in price-fixing and collusion. Requirements to jointly negotiate aggregate royalty rates should thus be accompanied by safeguards and guidance that ensure such negotiations comply with antitrust law. An example would be royalty-rate negotiations in patent pools, where pool administrators take a mediatory role, collecting and protecting confidential information from pool members.[73]

It is also unclear whether these joint royalty negotiations would be of much use to either inventors or implementers. For example, the EU has proposed introducing an aggregate notification regulation along these lines. The regulation appears to allow multiple groups of SEP owners to jointly notify their views concerning the appropriate royalties for a given technology. This could add even more confusion for standard implementers. For example, some SEP owners could announce an aggregate rate of $10 per product, another 5% of the end-product price, while a third group would prefer a lower $1 per-product rate.

Moreover, it is unclear how joint aggregate royalty-rate notifications would change the existing practice of unilateral announcement of licensing terms. Many SEP owners already publicly announce their royalty programs in advance. To be on the safe side, SEP owners may simply notify their maximum preference, knowing that negotiations would lead to different prices depending on the unique details of various licensees. As a result, aggregate royalty rates may not produce meaningful data points.

Nonbinding expert opinions on global aggregate royalty rates could also add to the confusion. Implementers would likely initiate the process, which would then proceed in parallel with SEP owners’ joint notifications of aggregate rates. All these differing and possibly conflicting estimates might lead to even greater uncertainty. Moreover, if those providing nonbinding opinions are not universally regarded as “experts,” the parties are unlikely to respect such opinions.

Aggregate royalty notifications and nonbinding opinions might be used in the top-down method for FRAND-royalty determinations. A top-down method provides that the SEP owner should receive a proportional share of a standard’s total aggregate royalty. It requires establishing a cumulative royalty for a standard and then calculating the share of the total royalty for an individual SEP owner. This may be the reason for having aggregate royalty-rate notifications and opinions. At the same time, essentiality checks would still be needed to filter out which patents are truly essential, and to assess each individual SEP owner’s share.

We caution strongly against relying too heavily on the top-down approach for FRAND-royalty determinations. It is not used in commercial-licensing negotiations, and courts have frequently rejected its application. Industry practice is to use comparable licensing agreements. The top-down approach was applied in Unwired Planet v Huawei only as a cross-check for the rates derived from comparable agreements.[74] TCL v Ericsson relied on this method, but was vacated on appeal.[75] The most recent Interdigital v Lenovo judgment considered and rejected its use, finding “no value in Interdigital’s Top-Down cross-check in any of its guises.”[76] Moreover, the top-down approach, as currently applied, relies solely on patent counting. It fails to consider that not every patent is of equal value, nor that some patents may be invalid or not infringed by a specific device.

In short, there are important legal and practical obstacles to the joint negotiation of aggregate royalty rates. Legal mandates to conduct such negotiations would thus be of dubious added value to players in standard-reliant industries.

[1] U.S. Patent and Trademark Office, Joint ITA-NIST-USPTO Collaboration Initiative Regarding Standards, Federal Register (Sep. 27, 2023), https://www.federalregister.gov/documents/2023/09/27/2023-20919/joint-ita-nist-uspto-collaboration-initiative-regarding-standards; U.S. Patent and Trademark Office, Joint ITA–NIST–USPTO Collaboration Initiative Regarding Standards; Notice of Public Listening Session and Request for Comments, Federal Register (Sep. 11, 2023), available at https://www.govinfo.gov/content/pkg/FR-2023-09-11/pdf/2023-19667.pdf (“Call for Comments”).

[2] European Commission, Explanatory Memorandum for Proposal for a Regulation of the European Parliament and of the Council on Standard Essential Patents and Amending Regulation (EU) 2017/1001, COM (2023) 232 Final (“Explanatory Memorandum”).

[3] See, e.g., Dirk Auer & Julian Morris, Governing the Patent Commons, 38 Cardozo Arts & Ent. L.J. 294 (2020).

[4] See, e.g., Alexander Galetovic, Stephen Haber & Ross Levine, An Empirical Examination of Patent Holdup, 11 J. Competition L. & Econ. 549 (2015). This is in keeping with general observations about the dynamic nature of intellectual property protections. See, e.g., Ronald A. Cass & Keith N. Hylton, Laws of Creation: Property Rights in the World of Ideas 42-44 (2013).

[5] Oscar Borgogno & Giuseppe Colangelo, Disentangling the FRAND Conundrum, DEEP-IN Research Paper (Dec. 5, 2019) at 5, available at https://ssrn.com/abstract=3498995.

[6] Richard A. Epstein & Kayvan B. Noroozi, Why Incentives for “Patent Holdout” Threaten to Dismantle FRAND, and Why It Matters, 32 Berkeley Tech. L.J. 1381, 1411 (2017).

[7] Borgogno & Colangelo, supra note 5, at 5.

[8] Call for Comments, supra note 1, Questions 1 and 2.

[9] Proposal for a Regulation of the European Parliament and of the Council on Standard Essential Patents and Amending Regulation (EU) 2017/1001, COM (2023) 232 Final (“Draft SEP Regulation”).

[10] Robin Jacob & Igor Nikolic, ICLE Comments Regarding the Draft Regulation on Standard Essential Patents (Jul. 28, 2023), available at https://laweconcenter.org/wp-content/uploads/2023/07/ICLE-Comments-to-the-SEP-Regulation.pdf.

[11] Call for Comments, supra note 1, Question 3.

[12] See, e.g., Jorge Padilla, John Davies, & Aleksandra Boutin, Economic Impact of Technology Standards: The Past and the Road Ahead (2017), available at https://www.compasslexecon.com/wp-content/uploads/2018/04/CL_Economic_Impact_of_Technology_Standards_Report_FINAL.pdf (Section 3 has an in-depth discussion of the adoption of standards and the benefits to the growth of mobile technology); iRunway, Patent & Landscape Analysis of 4G-LTE Technology 9-12 (2012), https://www.i-runway.com/images/pdf/iRunway%20-%20Patent%20&%20Landscape%20Analysis%20of%204G-LTE.pdf.

[13] See, e.g., Galetovic, et al., supra note 4; Keith Mallinson, Don’t Fix What Isn’t Broken: The Extraordinary Record of Innovation and Success in the Cellular Industry under Existing Licensing Practices, 23 Geo. Mason L. Rev. 967 (2016); Damien Geradin, Anne Layne-Farrar, & Jorge Padilla, The Complements Problem within Standard Setting: Assessing the Evidence on Royalty Stacking, 14 B.U. J. Sci. & Tech. L.144 (2008).

[14] Auer & Morris, supra note 3, at 5.

[15] Epstein & Noroozi, supra note 6, at 1394.

[16] See, e.g., Daniel F. Spulber, Standard Setting Organisations and Standard Essential Patents: Voting and Markets, 129 Econ. J. 1477, 1502-03 (2018) (“The interaction between inventors and adopters helps explain the variation of decision rules among SSOs, ranging from majority rule to consensus requirements…. Technology standards will be efficient when SSO decision making reflects the countervailing effects of voting power and market power.”).

[17] See Kirti Gupta, How SSOs Work: Unpacking the Mobile Industry’s 3GPP Standards, in The Cambridge Handbook of Technical Standardization Law: Competition, Antitrust, and Patents (Jorge L. Contreras ed., 2017).

[18] See Kristen Jakobsen Osenga, Ignorance Over Innovation: Why Misunderstanding Standard Setting Organizations Will Hinder Technological Progress, 56 U. Louisville L. Rev. 159, 178 (2018); Andrew Updegrove, Value Propositions, Roles and Strategies: Participating in a SSO, in The Essential Guide to Standards, https://www.consortiuminfo.org/guide (last visited Jan. 23, 2022).

[19] Adapted from Auer & Morris, supra note 3, at 18-19.

[20] Andrew Updegrove, Business Considerations: Forming and Managing a SSO, in The Essential Guide to Standards, https://www.consortiuminfo.org/guide/forming-managing-a-sso/business-considerations (last visited Nov. 6, 2023).

[21] See, e.g., Jonathan M. Barnett, The Host’s Dilemma: Strategic Forfeiture in Platform Markets for Informational Goods, 124 Harv. L. Rev. 1861, 1883 (2010) (showing that firms routinely forfeit their intellectual assets in order to boost the growth of the platform they operate).

[22] See Joanna Tsai & Joshua D. Wright, Standard Setting, Intellectual Property Rights, and the Role of Antitrust in Regulating Incomplete Contracts, 80 Antitrust L.J. 157, 159 (2015) (“SSOs [standard-setting organizations] and their IPR policies appear to be responsive to changes in perceived patent holdup risks and other factors. We find the SSOs’ responses to these changes are varied, and that contractual incompleteness and ambiguity persist across SSOs and over time, despite many revisions and improvements to IPR policies. We interpret the evidence as consistent with a competitive contracting process and with the view that contractual incompleteness is an intended and efficient feature of SSO contracts.”) (emphasis added).

[23] See, e.g., Daniel F. Spulber, Licensing Standard Essential Patents with FRAND Commitments: Preparing for 5G Mobile Telecommunications, 18 Co. Tech. L.J. 79, 147 (2020) (“Adjudication of SEP disputes guided by common law principles and comparable licenses complements SSO FRAND commitments and market negotiation of SEP licenses. Adjudication based on common law and comparable licenses provides general rules for the resolution of SEP disputes that does not restrict SSO IP policies and or interfere with consensus decision making by SSOs. Such adjudication also does not interfere with efficient market negotiation of SEP licenses.”).

[24] Id. at 148.

[25] Osenga, supra note 19, at 213-14.

[26] Call for Comments, supra note 1, Questions 4, 5, 6.

[27] Draft SEP Regulation, preamble at (35).

[28] Richard A. Epstein, The Clear View of The Cathedral: The Dominance of Property Rules, 106 Yale L.J. 2091, 2091 (1996) (“Property rights are, in this sense, made absolute because the ownership of some asset confers sole and exclusive power on a given individual to determine whether to retain or part with an asset on whatever terms he sees fit.”)

[29] See generally Edmund W. Kitch, The Nature and Function of the Patent System, 20 J.L. & Econ. 265 (1977); F. Scott Kieff, Property Rights and Property Rules for Commercializing Inventions, 85 Minn. L. Rev. 697 (2001).

[30] See, e.g., Barnett, supra note 22, at 856 (“Strong patents provide firms with opportunities to disaggregate supply chains through contract-based relationships, which in turn give rise to trading markets in intellectual resources, whereas weak patents foreclose those options.”).

[31] Dirk Auer, Geoffrey A. Manne, Julian Morris, & Kristian Stout, The Deterioration of Appropriate Remedies in Patent Disputes, 21 Federalist Soc’y Rev. 158, 160 (2020).

[32] Id. at 163.

[33] See, e.g., Doris Johnson Hines & J. Preston Long, The Continuing (R)evolution of Injunctive Relief in the District Courts and the International Trade Commission, IP Litigator (Jan./Feb. 2013) (citing Tracy Lee Sloan, The 1988 Trade Act and Intellectual Property Cases Before the International Trade Commission, 30 Santa Clara L. Rev. 293, 302 (1990) (“Out of 221 intellectual property cases between 1974 and 1987, the ITC found that only five failed to establish sufficient injury… for injunctive-type relief.”)), available at https://www.finnegan.com/en/insights/articles/the-continuing-r-evolution-of-injunctive-relief-in-the-district.html.

[34] And even then, the specific contribution of a particular patent to ultimate consumer value will remain uncertain. See Robert P. Merges, Of Property Rules, Coase, and Intellectual Property, 94 Colum. L. Rev. 2655, 2659 (1994) (“The problems with [clearly defining harms/benefits] in the IPR field result from the abstract quality of the benefits conferred by prior works and the cumulative, interdependent nature of works covered by IPRs. Valuation, then, is at least as great a problem as detection.”)

[35] See Richard Epstein, F. Scott Kieff, & Daniel Spulber, The FTC, IP, and SSOs: Government Hold-Up Replacing Private Coordination, 8 J. Competition L. & Econ. 1 (2012) at 21, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1907450 (“The simple reality is that before a standard is set, it just is not clear whether a patent might become more or less valuable. Some upward pressure on value may be created later to the extent that the patent is important to a standard that is important to the market. In addition, some downward pressure may be caused by a later RAND commitment or some other factor, such as repeat play. The FTC seems to want to give manufacturers all of the benefits of both of these dynamic effects by in effect giving the manufacturer the free option of picking different focal points for elements of the damages calculations. The patentee is forced to surrender all of the benefit of the upward pressure while the manufacturer is allowed to get all of the benefit of the downward pressure.”).

[36] Merges, supra note 38, at 2666-67 (quoting A. Mitchell Polinsky, Resolving Nuisance Disputes: The Simple Economics of Injunctive and Damage Remedies, 32 Stan. L. Rev. 1075, 1092 (1980)).

[37] See Auer, et al., supra note 35, at 163 (“It also establishes this lower royalty rate as the ‘customary’ rate, which ensures that subsequent royalty negotiations, particularly in the standard-setting context, are artificially constrained.”).

[38] eBay Inc. v. MercExchange, LLC, 547 U.S. 388 (2006).

[39] See Benjamin Petersen, Injunctive Relief in the Post-eBay World, 23 Berkeley Tech. L.J. 193, 196 (2008), (“In the two years after the Supreme Court’s ruling in eBay, there were thirty-three district court decisions that interpreted eBay when determining whether to grant injunctive relief to a patent holder. Of these decisions, twenty-four have granted permanent injunctions and ten have denied injunctions.”). See also Bernard H. Chao, After eBay, Inc. v. MercExchange: The Changing Landscape for Patent Remedies, 9 Minn. J.L. Sci. & Tech. 543, 572 (2008) (“For the first time, courts are not granting permanent injunctions to many successful patent plaintiffs.”); Robin M. Davis, Failed Attempts to Dwarf the Patent Trolls: Permanent Injunctions in Patent Infringement Cases Under the Proposed Patent Reform Act of 2005 and eBay v. MercExchange, 17 Cornell J.L. & Pub. Pol’y 431, 444 (2008) (“However, the first few district courts deciding patent cases following that decision granted injunctions to patent owners in the majority of cases, at a rate of approximately two-to-one.”).

[40] See generally Epstein & Noroozi, supra note 6, at 1406-08.

[41] Vincenzo Denicolò, Damien Geradin, Anne Layne-Farrar & A. Jorge Padilla, Revisiting Injunctive Relief: Interpreting eBay in High-Tech Industries with Non-Practicing Patent Holders, 4 J. Comp. L. & Econ. 571 (2008).

[42] Id. at 608. See also Vincenzo Denicolò, Do Patents Over-Compensate Innovators?, 22 Econ. Pol’y 681 (2007) (noting that, with respect to patents in general, “a preponderance of what evidence is currently available points against the over-reward hypothesis”).

[43] See, e.g., Mark Schankerman & Suzanne Scotchmer, Damages and Injunctions in Protecting Intellectual Property, 32 RAND J. Econ. 201 (2001).

[44] Epstein & Noroozi, supra note 6, at 1408.

[45] Tsai & Wright, supra note 23, at 163.

^[46] James Ratliff & Daniel L. Rubinfeld, The Use and Threat of Injunctions in the RAND Context, 9 J. Competition L. & Econ. 14 (2013).

^[47] Ratliff & Rubinfeld, supra note 50, at 7 (emphasis added).

[48] Tsai & Wright, supra note 23, at 182.

[49] Call for Comments, supra note 1, Question 9.

[50] See, e.g., Rudi Bekkers, Christian Catalini, Arianna Martinelli, Cesare Righi, and Timothy Simcoe. Disclosure Rules and Declared Essential Patents, 52 Research Policy, 104618, 3 (2023) (“Thus, allowing blanket disclosure can be efficient if the main purpose of a disclosure policy is to reassure prospective implementers that a license will be available. On the other hand, blanket disclosure shifts search costs from the patent holder (who presumably has a comparative advantage at finding its own essential patents) onto other interested parties, such as prospective licensees who wish to evaluate the scope and value of a firm’s dSEPs; other SSO participants seeking to make explicit cost-benefit comparisons of alternative technologies before committing to a standard; and regulators or courts that might use information about relevant dSEPs to determine reasonable royalties.”).

[51] See Jacob & Nikolic, supra note 10.

[52] See European Commission, Impact Assessment Report Accompanying the Document Proposal for a Regulation of the European Parliament and of the Council on Standard Essential Patents and Amending Regulation (EU) 2017/1001, SWD(2023) 124 final (“Impact Assessment”), at 101.

[53] Call for Comments, supra note 1, Question 10.

[54] See, e.g., U.S. Patent Office, Intellectual Property and the U.S. Economy: 2016 Update (2016), available at https://www.uspto.gov/sites/default/files/documents/IPandtheUSEconomySept2016.pdf.

[55] Shayerah Ilias Akhtar, Liana Wong & Ian F. Fergusson, Intellectual Property Rights and International Trade, at 6 (Congressional Research Service, May 12, 2020), available at https://crsreports.congress.gov/product/pdf/RL/RL34292 (“Intellectual property generally is viewed as a long-standing strategic driver of U.S. productivity, economic growth, employment, higher wages, and exports. It also is considered a key source of U.S. comparative advantage, such as in innovation and high-technology products. Nearly every industry depends on it for its businesses. Industries that rely on patent protection include the aerospace, automotive, computer, consumer electronics, pharmaceutical, and semiconductor industries.”).

[56] See, e.g., Martina F. Ferracane & Hosuk Lee-Makiyama, China’s Technology Protectionism and Its Non-negotiable Rationales, ECIPE (Jun. 2017), available at https://ecipe.org/publications/chinas-technology-protectionism. Consider that, even for actual citizens of the People’s Republic of China, individual rights are legally subordinate to “the interests of the state.” Const. of the People’s Rep. of China, Art. 51, available athttp://www.npc.gov.cn/englishnpc/constitution2019/201911/1f65146fb6104dd3a2793875d19b5b29.shtml. One has to imagine that the level of legal protections afforded foreign firms is no better, and surely must be subordinate to the objectives of China’s industrial policy, including the goal of leapfrogging the United States in IP production. See, e.g., Karen M. Sutter, “Made in China 2025” Industrial Policies: Issues for Congress (Congressional Research Service, Aug. 11, 2020), available at https://sgp.fas.org/crs/row/IF10964.pdf.

[57] See China Is Becoming More Assertive in International Legal Disputes, The Economist (Sep. 18, 2021), https://www.economist.com/china/2021/09/18/china-is-becoming-more-assertive-in-international-legal-disputes (“In the past year Chinese courts have issued sweeping orders on behalf of Chinese smartphone-makers that seek to prevent lawsuits against them in other countries over the use of foreign companies’ intellectual property… so that they (rather than foreign courts) can decide how much Chinese firms should pay in royalties to the holders of patents that their products use.”).

[58] See Matthew Laight, Shifting landscape in SEP FRAND litigation – 2021 will see hard fought disputes in China and India, digital business (Dec. 9, 2020), https://digitalbusiness.law/2020/12/shifting-landscape-in-sep-frand-litigation-2021-will-see-hard-fought-disputes-in-china-and-india.

[59] See RPX Corporation, China: Chinese Courts Can Set Global SEP License Terms, Rules Supreme People’s Court, Mondaq (Oct. 21, 2021), https://www.mondaq.com/china/patent/1120114/chinese-courts-can-set-global-sep-license-terms-rules-supreme-people39s-court.

[60] Id.

[61] See Rush Doshi, Emily De La Bruye?re, Nathan Picarsic, & John Ferguson, China as a “Cyber Great Power”: Beijing’s Two Voices in Telecommunications, Brookings Institute Foreign Policy Paper (Apr. 2021) at 16, available at https://www.brookings.edu/wp-content/uploads/2021/04/FP_20210405_china_cyber_power.pdf. (“In March 2018, Beijing launched the China Standards 2035 project, led by the Chinese Academy of Engineering. After a two-year research phase, that project evolved into the National Standardization Development Strategy Research in January 2020. The ‘Main Points of Standardization Work in 2020’ issued by China’s National Standardization Committee in March 2020 outlined intentions to ‘strengthen the interaction between the standardization strategy and major national strategies.’”).

[62] Quoted in id.

[63] Id. “The phrase ‘cyber great power’ is a key concept guiding Chinese strategy in telecommunications as well as IT more broadly. It appears in the title of almost every major speech by President Xi Jinping on China’s telecommunications and network strategy aimed at a domestic audience since 2014. But the phrase is rarely found in messaging aimed at external foreign audiences, appearing only once in six years of remarks by Foreign Ministry spokespersons. This suggests that Beijing intentionally dilutes discussions of its ambitions in order not to alarm foreign audiences.” Id. at 3 (emphasis added).

[64] See Danny Russel & Blake Berger, Is China Stacking the Technology Deck by Setting International Standards?, The Diplomat (Dec. 2, 2021), https://thediplomat.com/2021/12/is-china-stacking-the-technology-deck-by-setting-international-standards.

[65] Emily de la Bruyere, China’s Quest to Shape the World Through Standards Setting, Hinrich Foundation (Jul. 2021), at 11 (emphasis added), available at https://www.hinrichfoundation.com/research/article/tech/china-quest-to-shape-the-world-through-standards-setting.

[66] Although China is currently under-represented in most SDOs, that is already rapidly changing. See Justus Baron & Olia Kanevskaia, Global Competition for Leadership Positions in Standards Development Organizations, Working Paper (Mar. 31, 2021), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3818143. As Baron and Kanevskaia note, “[t]he surge in the number of leadership positions held by Huawei… [have] raised concerns that… Huawei [may] gain an undue competitive advantage over Western commercial and strategic interests.” Id. at 2.

[67] Updegrove, supra note 19.

[68] See id. at 30-36 (surveying the economic benefits from standardization). See also Soon-Yong Choi & Andrew B. Whinston, Benefits and Requirements for Interoperability in the Electronic Marketplace, 2 Tech. in Soc’y 33, 33 (2000) (“Economic benefits of interoperability result in lowered production or transaction costs typically utilizing standardized parts or automated processes. In the networked economy, the need for interoperability extends into an entire commercial processes, market organizations and products.”).

[69] Anna Gross, Madhumita Murgia & Yuan Yang, Chinese Tech Groups Shaping UN Facial Recognition Standards, Financial Times (Dec. 1, 2019), https://www.ft.com/content/c3555a3c-0d3e-11ea-b2d6-9bf4d1957a67 (“‘The drive to shape international standards… reflects longstanding concerns that Chinese representatives were not at the table to help set the rules of the game for the global Internet,’ the authors of the New America report wrote. ‘The Chinese government wants to make sure that this does not happen in other ICT spheres, now that China has become a technology power with a sizeable market and leading technology companies, including in AI.’”).

[70] Russel & Berger, supra note 67.

[71] Request for Comments, supra note 1,  Question 11.

[72] Igor Nikolic, Licensing Negotiations Groups for SEPs: Collusive Technology Buyers Arrangements? Their Pitfalls and Reasonable Alternatives, Les Nouvelles 350 (2021).

[73] Hector Axel Contreras & Julia Brito, Patent Pools: A Practical Perspective – Part II, Les Nouvelles 39 (2022).

[74] Unwired Planet v Huawei [2017] EWHC 711 (Pat).

[75] TCL v Ericsson, Case No. 8:14-cv-003410JVS-DFM (C.D. Cal. 2018); TCL v Ericsson, 943 F.3d 1360 (Fed. Cir. 2019)

[76] Interdigital v Lenovo [2023] EWHC 539 (Pat) 733.

Fast Company – ICLE Director of Law & Economics Programs Gus Hurwitz was quoted by Fast Company about the lawsuit filed by Meta challenging the constitutionality of the Federal Trade Commission’s enforcement actions. You can read full piece here.

But it’s a gamble that could pay off, suggest legal experts. “It’s a potentially valid argument they have to defend themselves against FTC litigation,” says Gus Hurwitz, senior fellow and academic director specializing in tech competition and innovation at the University of Pennsylvania Carey Law School. “They’re being sued, they want to win. You can win on the substance, or you can win procedurally. When you’re a lawyer defending your client, it doesn’t matter how you win. It’s pretty superficial to call this a low blow.”

Some have criticized Meta’s legal tactic. But while Hurwitz is wary of psychoanalyzing what he calls the “Twitter commentariat,” he says that Meta could have a point—both with the bald facts of the case and also because of the broader implications. “The reality is, we need people to bring these sorts of arguments in order to shape and develop the law,” he says.

“Fundamentally, I think it comes down to the use of the role of government, government authority, and government power,” says Hurwitz. Some say it’s obvious that companies like Meta should be regulated by the FTC. Others argue that agencies like the FTC have too broad a remit and shouldn’t be allowed to act without direct oversight from Congress. “The reality is probably somewhere in between: that there is some reasonable amount of authority for the FTC to have,” says Hurwitz. “We’re in a new and still new and complicated legal setting. And it’s unclear what Congress intended. It’s unclear what the boundaries are. And those are questions for the courts or Congress ultimately to resolve. And that’s what this case is going to be about.”

WCPO-TV – ICLE Senior Scholar Eric Fruits was quoted by WCPO-TV in Cincinnati about the role of the so-called “waterbed effect” in potential challenges of the proposed merger of supermarkets Kroger and Albertsons. You can read full piece here.

And that’s why some think an economic theory known as the waterbed effect could influence the outcome, said Eric Fruits, an antitrust expert and senior scholar for the International Center for Law & Economics in Portland, Oregon.

“If you sit on one part of a waterbed, that part sinks down and then another part rises up,” Fruits said. “As a large firm pushes down prices that they pay, other firms pay higher prices. And so there’s this argument that through this waterbed effect, other firms might be harmed.”

Fruits was the co-author of an October 17 white paper that predicts the FTC will lose if it challenges the merger in court. The waterbed argument is one reason he thinks the FTC will lose.

“The waterbed effect is mostly theoretical,” Fruits said. “There’s never been a demonstration of it in grocery markets. The UK has subjected at least two mergers to waterbed type scrutiny and found that there is no waterbed effect.”

Market Power – ICLE Chief Economist Brian Albrecht was cited by the YouTube show Market Power in a video about the craft of economics. You can watch full piece here.

Who is someone I see as a master of the craft of economics? And one person rose to my mind. Every time I see him write about an economics topic, his thinking is clear, careful, and interesting. I’m thinking of Brian Albrecht.

Travel Awaits – ICLE Senior Scholar Julian Morris was quoted by Travel Awaits in a story about the Credit Card Competition Act’s impact on airlines. You can read full piece here.

In a white paper about the subject, Julian Morris, a senior scholar at the International Center for Law & Economics, argued that the legislation would likely only benefit credit card networks that aren’t Visa or Mastercard as well as big-box retailers. “Unfortunately, the number and scale of those who lose is likely to be far greater than the number and scale of those who win,” Morris wrote.

Morris described the legislation as causing significant disruption with airline-branded credit cards, which are a steady revenue stream for airlines. He explained that airline companies generate relatively thin profit margins, so they rely on revenue generated from loyalty programs in both good and bad economic times. In fact, most of the major airlines report earning nearly $4 billion in annual revenue from co-branded credit cards. He also explained that cardholders with travel rewards rely on the points and discounts that come with their credit cards and for that reason, the programs are popular.

The potential consequence of the bill, as Morris explained, is that credit card companies may offer fewer benefits and discounts. He also argued that the current networks maintain a high standard of security that third-party networks might not be able to match. He added that while airlines may start offering loyalty programs using different networks, they would need customers to either agree to new terms or switch programs. He called it “a timing mismatch effect.”

Communications Daily – ICLE Director of Innovation Policy Kristian Stout was quoted by Communications Daily in a story about efforts to change the rules for low-Earth-orbit satellites. You can read full piece here.

Between “inertia” in the ITU process and opposition from geostationary orbit (GSO) operators, building support for the FAI will be difficult, acknowledged Kristian Stout, director-innovation policy, International Center for Law & Economics (ICLE). At the same time, it’s helped by not being about only American NGSO operators. Nations interested in entering low earth orbit (LEO) space will be sensitive that their space companies will favor EPFD rules changes, he said.

ICLE — along with Amazon’s Kuiper, New America’s Open Technology Institute and the Digital First Project — make up the FAI-advocating Alliance for Satellite Broadband (see 2310310039).

The Deal – An ICLE white paper about the proposed merger of Kroger and Albertsons was mentioned in a story from The Deal. You can read full piece here.

PORTLAND, Ore. (Nov. 15, 2023) – The International Center for Law & Economics (ICLE) offers the following statement from ICLE Director of Innovation Policy Kristian Stout in response to today’s Federal Communications Commission (FCC) vote to adopt “digital discrimination” rules pursuant to the Biden administration’s larger digital equity plan and its interpretation of the relevant provisions of the Infrastructure Investment and Jobs Act (IIJA):

The FCC has unfortunately chosen to move forward with highly controversial provisions of its digital-discrimination rulemaking, including the adoption of a disparate-impact standard and an extension of the rules to cover broadband service characteristics, such as pricing and quality. Such rules will have a host of unintended consequences, including introducing de facto rate regulation, which the FCC has historically eschewed. The move is particularly curious given the Supreme Court’s emerging “major questions” jurisprudence, which will pose a major obstacle for the FCC to implement these rules.

For more on the topic, see ICLE’s reply comments to the FCC, as well as this ex parte letter and this “tl;dr” explainer. To schedule an interview with Kristian about the FCC’s planned regulations, contact ICLE Media and Communications Manager Elizabeth Lincicome at [email protected] or (919) 744-8087.

The Spokesman-Review – An ICLE white paper about the proposed merger of Kroger and Albertsons was cited in an op-ed that appeared in The Spokesman-Review. You can read full piece here.

Even if the Albertsons-Kroger merger proceeds, it would account for just 9% of nationwide sales, according to the International Center for Law and Economics. But what it would do is get the attention of the big three — increasing competition with their 42% of the current market share.

Communications Daily – ICLE comments to the Federal Communications Commission regarding digital discrimination in broadband were cited by Communications Daily in a story about the National Telecommunications and Information Administration’s comments on the subject. You can read full piece here.

The International Center for Law & Economics agreed, adding the FCC “has for years been explicit about its apprehension to impose direct rate regulation.” It also asked the agency to reject NTIA’s proposal to adopt a disparate impact standard in the definition of digital discrimination. “Mere statistical correlation between outcomes and protected characteristics is insufficient to demonstrate discrimination,” the group said.

Wall Street Journal – ICLE Academic Affiliate Lars Powell was quoted by the Wall Street Journal in a story about Alabama’s insurance market. You can read full piece here.

Home-insurance premiums in the counties have fluctuated but generally declined in recent years, according to data compiled by Lars Powell, director of the Alabama Center for Insurance Information and Research at the University of Alabama. The average premium was $1,243 in 2021, the most recent year for which data is available, compared with $1,396 in 2015.

San Francisco Chronicle – An ICLE white paper about California’s Proposition 103 insurance-regulatory system  was cited in editorial in the San Francisco Chronicle. You can read full piece here.

“Prop. 103 has created an insurance market that struggles to work efficiently even in the best of times and is virtually impossible to sustain in periods of acute stress,” concluded a white paper the International Center for Law & Economics released Monday.

Supermarket News – ICLE Senior Scholar Eric Fruits was cited by Supermarket News in an item about a recent podcast he recorded on the proposed merger of supermarkets Kroger and Albertsons. You can read full piece here.

Merger on the mind: Imagine a world where grocery prices remained competitive and job security was locked in after the Kroger, Albertsons merger. That might not be such a stretch, according to Eric Fruits, senior scholar at the International Center for Law and Economics and co-author of the white paper titled, “Food-Retail Competition, Antitrust Law, and the Kroger/Albertsons Merger.” Have 20 minutes? You can catch my interview with Fruits in the latest episode of our SN off the Shelf podcast. In a nutshell, he says the Kroger, Albertsons merger checks all the boxes when you look at other successful mergers in retail history. He also believes the Federal Trade Commission will take both Kroger and Albertsons to court about the deal, and other states could follow suit. Don’t get your hopes up if you were betting on the merger kicking in next year. —Bill Wilson

Supermarket News – ICLE Senior Scholar Eric Fruits was cited by Supermarket News in an item about a recent podcast he recorded on the proposed merger of supermarkets Kroger and Albertsons. You can read full piece here.

But what if grocery prices remained competitive after the merger and a minimal number of jobs were lost? It most likely will happen, according to Eric Fruits, senior scholar at the International Center for Law and Economics. Fruits is the co-author of the white paper titled, “Food-Retail Competition, Antitrust Law, and the Kroger/Albertsons Merger.”

In the latest episode of SN Off the Shelf, Supermarket News Senior Editor Bill Wilson talks with Fruits about the Kroger, Albertsons merger which, according to Fruits, enough has been done to satisfy the parameters of a fair deal.

American Legislative Exchange Council – ICLE Director of Innovation Policy Kristian Stout was cited by the American Legislative Exchange Council in a blog post about President Joe Biden’s executive order on artificial intelligence. You can read full piece here.

As Kristian Stout of the International Center for Law and Economics noted, violations of the Defense Production Act are federal felonies and can result in fines of up to $10,000 and even imprisonment. This new web of regulatory red tape, coupled with the potential for severe federal penalties, may have an adverse impact on startups hoping to break into this space and incumbent software developers alike.

Supermarket News – An ICLE white paper about the proposed merger of Kroger and Albertsons was mentioned in a story from Supermarket News. You can read full piece here.

The International Center for Law & Economics last month pointed out in a white paper that the FTC has in the past 35 years approved almost all grocery industry mergers, provided the two companies divest certain stores in markets where they both operate.

Law360 – ICLE’s participation in the Alliance for Satellite Broadband was mentioned in a Law360 story about the coalition’s launch. You can read full piece here.

WCPO-TV – An ICLE white paper about the proposed merger of Kroger and Albertsons was cited by WCPO-TV in Cincinnati in a story about the companies’ proposed divestitures. You can read full piece here.

The International Center for Law & Economics said that kind of talk puts Khan “on a collision course with the law.” Its Oct. 17 white paper predicts the FTC will lose if it challenges the Kroger-Albertsons merger.

“Only one supermarket merger has been challenged in court since American Store’s acquisition of Lucky Stores in 1988: the Whole Foods/Wild Oats merger in 2007. Over the last 35 years, the FTC has allowed every other supermarket merger and most retail-store transactions to proceed with divestitures,” said the report.

Colorado Sun – An ICLE white paper about the proposed merger of Kroger and Albertsons was cited by the Colorado Sun. You can read full piece here.

The FTC has rarely interfered with grocery mergers because companies have divested stores to meet regulatory requirements, according to a new white paper from the International Center for Law & Economics, a nonprofit and nonpartisan research center. Only one has been challenged in court since 1988: the tie up Whole Foods and Wild Oats in 2007.

“Over the last 35 years, the FTC has allowed every other supermarket merger and most retail-store transactions to proceed with divestitures,” according to the paper. “The FTC’s historic approach recognizes the reality that competitive concerns regarding supermarket mergers can be readily and adequately remedied by divestitures in geographic markets of concern.”

Americans for Tax Reform – ICLE research on payment cards’ “rewards” programs was cited by Americans for Tax Reform in a recent blog post. You can read full piece here.

The CCCA would require the Federal Reserve to publish rules that would force credit cards issued in the U.S. to be enabled with at least two unaffiliated payment card networks. The ostensible goal of the bill is to let merchants dictate the networks to be used on consumers’ cards. This will result in a loss of interchange fee revenue, which is used to pay for frequent flyer programs. Enacting this bill could result in the termination of these programs—impacting approximately 30 million Americans with airline co-branded credit cards. According to data cited by the International Center for Law and Economics (ICLE), in terms of all types of rewards cards, “86% of credit cardholders have active rewards cards, including 77% of cardholders with a household income of less than $50,000.”

Communications Daily – ICLE’s participation in the Alliance for Satellite Broadband was mentioned in a Communications Daily story about the coalition’s launch. You can read full piece here.

Amazon, the International Center for Law & Economics, New America’s Open Technology Institute and the Digital First Project have jointly launched the Alliance for Satellite Broadband to push for updates to satellite power limit rules at the 2023 World Radiocommunication Conference.

Cincinnati Business Courier – An ICLE white paper about the proposed merger of Kroger and Albertsons was mentioned in a news roundup from the Cincinnati Business Courier. You can read full piece here.

5) Kroger-Albertsons merger analysis says regulators should approve acquisition but might not

Kroger Co.’s planned $24.6 billion acquisition of Albertsons Cos. Inc. should get approval from antitrust regulators, a global think tank’s new analysis shows. But whether it will or not is another question. Analysts at the International Center for Law & Economics, a Portland, Ore.-based nonpartisan research center, say changes in the competitive landscape and the rise of e-commerce mean there’s no reason for regulators to reject the deal.

Payload – ICLE’s participation in the Alliance for Satellite Broadband was mentioned in a Payload story about the coalition’s launch. You can read full piece here.

ICLE Academic Affiliate F. Scott Kieff joined the Understanding IP Matters podcast to discuss the challenges faced by U.S. inventors who rely on the legal system, as well as the history, politics, and enforcement of intellectual-property rights. Audio of the full episode is embedded below.

ICLE Senior Scholar Lazar Radic took part in a digital panel on ex ante regulation of digital markets hosted by the Legal Grounds Institute. Video of the full event is embedded below.

ICLE Director of Competition Policy Dirk Auer joined as a panelist in a webinar organized by ECIPE on platform regulation and merger policy in the EU, and the implications for member states’ attractiveness for digital investment. Video of the full panel is embedded below.

ICLE Senior Scholar Eric Fruits joined Supermarket News‘ SN Off the Shelf podcast to discuss the proposed merger of Kroger and Albertsons and the likelihood that the Federal Trade Commission will attempt to block the deal. Video of the full episode is embedded below.

ICLE Director of Innovation Policy Kristian Stout joined fellow panelists Timothy B. Lee and Pamela Samuelson and moderator Brent Skorup to discuss the emerging legal issues surrounding artificial intelligence and its use of works protected under copyright law on a recent episode of the Federalist Society Regulatory Transparency Project’s Fourth Branch Podcast. The full episode is embedded below.

Abstract

The European Commission’s recently unveiled proposal to overhaul the EU’s licensing system for standard-essential patents (SEPs) would see conciliators issue mandatory, albeit nonbinding, pre-trial determinations of fair, reasonable, and non-discriminatory (FRAND) terms. This issue brief investigates the relationship between the proposal’s FRAND-determination process and the test developed by the Court of Justice of the European Union (CJEU) in Huawei v. ZTE, which currently represents the guiding framework for SEP-licensing negotiations in the EU. It aims to demonstrate that, even if the SEP proposal were not intended to displace Huawei, the anti-injunction approach it endorses is inherently inconsistent with the CJEU’s stance, and is essentially a direct response to German case law. Therefore, to the extent that the proposal’s FRAND determinations will coexist with the Huawei bargaining framework, the proposed regulation appears likely to add significant confusion and uncertainty, and to induce licensing disputes, rather than supporting balanced and successful SEP-licensing negotiations.

I.       Introduction

In April 2023, the European Commission unveiled a proposed regulation to overhaul the EU’s licensing system for standard essential patents (SEPs).[1] The initiative aims to address the causes of allegedly inefficient licensing, such as a lack of transparency with regard to SEPs; fair, reasonable, and non-discriminatory (FRAND) terms and conditions; licensing in the value chain; and limited use of dispute-resolution procedures.[2]

A perceived need to enhance transparency, predictability, and efficiency of SEP licensing is not new to the EU policy agenda.[3] The status quo is perceived as particularly unsatisfactory in the context of the Internet of Things (IoT), where newer players with few resources and little licensing experience (i.e., startups and small and medium-sized enterprises) have entered the market for connectivity.[4] As the number of declared SEPs continues to proliferate and a growing number of industrial, business, and consumer applications make use of standards that include SEPs, the European Commission has increasingly seen the need for a smoother and more balanced SEP-licensing system.[5]

Against this background, the Commission’s SEP proposal would alter the current framework by introducing mandatory registration for enforcement purposes; a system for essentiality checks; and a process to determine both aggregate royalties and FRAND terms and conditions. Unsurprisingly, the proposal has drawn criticism for nearly all its provisions, with some questioning its very rationale. Critics charge that such an intrusive and extensive intervention is unnecessary and dangerous, and that there is no economic justification for the initiative.[6] Indeed, proponents of the proposed regulation justify it by citing limited circumstances and situate their case within a market-failure framework. There is, however, no discernible evidence of a market failure to address. Notably, the concerns reported in the Impact Assessment[7] do not match the results of the primary study that informed it.[8]

The Commission’s Impact Assessment raised concerns that SEP-related disputes will increase because of the growing demand for connectivity (particularly for the IoT) and that, because of high transaction costs and licensing uncertainties, both SEP owners and implementers may be discouraged from participating in standards development and the creation of products that use technology standards potentially subject to SEPs, respectively.[9] The empirical evidence that the Impact Assessment used as its primary input, however, does not support these findings and illustrates a significantly different landscape.

In short, the prevalence of SEP litigation is low relative to non-SEP disputes, and it has not increased over time;[10] the caseload of SEP litigation is relatively stable in Europe (while falling in the United States and increasing in China) and, in more recent years, the share of declared SEPs subject to litigation has fallen;[11] and empirically observable data do not indicate that SEP-licensing conditions have led to pervasive opt-outs from standards-related innovation.[12] Therefore, there is no evidence that FRAND-licensing frictions have caused either SEP owners to contribute less to standards development or SEP implementers to opt for alternative (i.e., without FRAND licensing) standards. There is also nothing to indicate that current SEP-licensing conditions systematically suppress or delay standards implementation.[13]

A further criticism directed at the Commission’s SEP proposal regards its decision to delegate the primary duties related to the licensing and litigation of SEPs to the European Union Intellectual Property Office (EUIPO).[14] The EUIPO has no meaningful experience with patents, but would be placed in charge of one of the most complex areas of patent policy.[15] Moreover, the tasks undertaken by EUIPO (more precisely, by the competence center established under the purview of EUIPO) would undermine the authority in SEP enforcement of national courts and the newly established Unified Patent Court (UPC).

This issue brief will focus on provisions of the Commission’s proposal that would introduce mandatory (albeit nonbinding) pre-trial FRAND determinations by conciliators.[16] Under the SEP proposal, such dispute resolution must be initiated by the SEP holder or implementer prior to the initiation either of a patent-infringement claim or a request to determine or assess FRAND terms and conditions before a competent court of an EU member state.

The brief investigates the relationship between the proposed FRAND-determination process and the test developed by the Court of Justice of the European Union (CJEU) in the landmark ruling Huawei v. ZTE, which represents the current guiding framework for good-faith SEP-licensing negotiations.[17] Indeed, mandatory conciliation is expected to benefit SEP holders and implementers in reaching license agreements more quickly and without costly court proceedings, and it is proposed as a complement to—rather than replacement for—the Huawei process,[18] it is equally evident that the proposed regulation underscores the Commission’s dissatisfaction with the Huawei framework and its implementation by national courts.

Furthermore, the proposed approach marks a consequential departure from the one adopted by the CJEU. While the latter elaborated the so-called “willing licensee” test in order to strike a fair balance among the relevant interests, compulsory pre-trial conciliation would reduce the scope of injunctions for SEP holders beyond Huawei, tilting the balance in favor of implementers. Indeed, implementers would be free to challenge SEPs, but patent owners could not initiate infringement proceedings without first going through the mandatory FRAND-determination process. This issue brief aims to demonstrate that, even if the SEP proposal does not displace Huawei, the proposed conciliation process represents an attempt to discard the CJEU’s framework, rather than complement it.

Furthermore, the proposed restraints on the availability of injunctive relief would appear to reinstate the conflict between the Commission and the German courts that apparent prior to the Huawei decision, when opposing approaches emerged in the Motorola and Samsung cases[19] and the Orange Book Standard ruling, respectively.[20] It was the national courts’ differing interpretations of FRAND determination that provided the original impetus for harmonization at the EU level under Article 114 TFEU.[21] The largest number of SEP disputes are, however, litigated in Germany,[22] and the Commission has appeared sensitive to stakeholder complaints that German court practice is overly friendly to patent owners, and that it contradicts Huawei by expanding the availability of injunctions and amounts to a de facto reinstatement of Orange Book Standard.[23] As a result, the SEP proposal’s no-injunction approach, as well as the length of its proposed FRAND-determination procedure, may alter the bargaining process by imposing costs on patent owners and unduly favoring opportunistic behavior and delay tactics by implementers. The effect would be to make hold-out more attractive.

Finally, this brief questions the expected added value of the SEP proposal’s conciliation process. While distrust of the role of courts in FRAND disputes finds no support in the empirical evidence—which instead demonstrates the absence of an SEP-litigation problem in the EU—the new provisions risk generating confusion and uncertainty, which could fuel further litigation. Such risk is further exacerbated by the proposal’s extraterritorial effects. Indeed, while the regulation would apply only to patents in-force in the EU, the FRAND determination may refer to global rates.[24]

The remainder of this issue brief is structured as follows. Sections II and III compare FRAND determinations under the SEP proposal and the Huawei bargaining framework, respectively. Section IV addresses the relationship between the Huawei code of conduct and the solution advanced by the European Commission. Section V investigates the implications and potential side effects of the SEP proposal. Section VI concludes.

II.     FRAND Determinations Under the SEP Proposal

Disagreements regarding the meaning and implementation of FRAND (i.e., about what constitute FRAND terms and conditions, as well as the nature, scope, and implications of FRAND obligations) are among the primary drivers of complexity in SEP licensing.[25] To reduce costs and simplify and speed negotiation of FRAND terms,[26] Title VI of the Commission’s SEP proposal introduces mandatory dispute resolution, which would serve as a precondition to access to the competent court of an EU member state. Indeed, a FRAND determination by a conciliator, selected among candidates proposed by the competence center,[27] would be a mandatory step before an SEP holder could initiate patent-infringement proceedings, or an implementer could request a determination or assessment of FRAND terms and conditions before a competent court.[28] National court enforcement would also be precluded when a determination of FRAND terms and conditions is raised in abuse-of-dominance cases, namely in the national application of the Huawei framework.[29]

The obligation to initiate FRAND determination before the relevant court proceedings is, however, not required for SEPs covering use cases of standards for which the Commission establishes (by means of a delegated act) that there is sufficient evidence that SEP-licensing negotiations on FRAND terms do not give rise to significant difficulties or inefficiencies.[30] Furthermore, the obligation to initiate FRAND determination does not preclude either party’s right to request (pending the FRAND determination) that the competent court of a member state issue a provisional injunction of a financial nature against the alleged infringer.[31] In any case, the provisional injunction would exclude seizure of the alleged infringer’s property, as well as the seizure or delivery of the products suspected of infringing an SEP.

While it would be obligatory to commence the conciliation before initiating a court action, the parties would be free to decide on their level of engagement and would not be prevented from leaving the process at any time.[32] It is even possible to proceed with the FRAND determination with the participation of just one party. Where a party does not reply to the FRAND determination request, or does not commit to comply with the outcome of the FRAND determination, the other party should be able to request either the termination or unilateral continuation of the FRAND determination.[33] The same applies if a party fails to engage in the FRAND determination after the conciliator has been appointed.[34] Where a parallel proceeding is initiated in a third country (i.e., a jurisdiction outside the EU) that results in a legally binding and enforceable decision, the conciliator (or the competence center) shall terminate the FRAND determination upon the request of any other party.[35]

The FRAND determination should be concluded within nine months.[36] At the conclusion of the procedure, the conciliator would make a proposal recommending a FRAND rate.[37] Either party would have the option to accept or reject the proposal. If the parties do not settle and/or do not accept the conciliator’s proposal, the conciliator would be asked to draft a report of the FRAND determination, including both a confidential and a non-confidential version. The latter should contain the proposal for FRAND terms and conditions and the methodology used, and should be provided to the competence center for publication in order to inform any subsequent FRAND determination between the parties and other stakeholders involved in similar negotiations. The Commission’s SEP proposal, however, offers no guidance on how conciliators should set a FRAND royalty or what factors they should consider.

III.   FRAND Determinations Under Huawei

Under existing European law, the evaluation of FRAND commitments in the standard development context is guided by the CJEU’s ruling in Huawei v. ZTE,[38] whose pivotal role was recently confirmed by the Commission’s guidelines on the application of antitrust law to horizontal cooperation agreements.[39]

Huawei represents the most significant attempt to provide a framework for good-faith SEP-licensing negotiations to guide licensors and licensees toward a mutually agreeable FRAND royalty. Toward this aim and in order to strike a fair balance among the relevant interests,[40] the CJEU identified the steps that patent holders and implementers must follow in negotiating a FRAND royalty. Indeed, a balance should be pursued between maintaining free competition and the requirement to safeguard a proprietor’s intellectual-property rights and its right to effective judicial protection.[41]

The exercise of an exclusive right linked to an intellectual-property right may in “exceptional circumstances” involve abusive conduct for the purposes of competition law.[42] In this regard, the CJEU has shown a preference for FRAND determination in the context of negotiations between the parties, using the threat of antitrust liability and patent enforcement as levers to steer both parties toward a mutually agreeable FRAND royalty level. Compliance with the Huawei code of conduct would shield SEP holders from the gaze of competition law and, at the same time, protect implementers from the threat of an injunction and the resulting disruptive effects on sales and production.

More specifically, transposing the essential-facility doctrine’s “exceptional circumstances” test to the standard development scenario,[43] the CJEU finds that the exceptional circumstances in this context are that the patent be essential to standards established by a development organization, and that those patents obtain essentiality status only in return for the holder’s irrevocable commitment to license on FRAND terms.[44]

These premises yield a willing-licensee test. While the alleged infringer must demonstrate more than just a mere willingness to negotiate, the SEP holder is burdened with making the first move and respecting the corresponding behavioral requirements. It is up to the SEP holder to alert the infringer of an alleged violation by naming the patent and specifying how it has been infringed. It is also up to the SEP holder to present a specific and written license offer on FRAND terms, specifying the amount of the royalty and how it is to be calculated.

By contrast, it is up to the alleged infringer to respond diligently to that offer, in accordance with well-established commercial practices, and in good faith, implying that the alleged infringer must not employ delay tactics. If the alleged infringer does not accept the offer, it must make a concrete counteroffer under FRAND conditions within a short period of time. From the point that this counteroffer is rejected by the patent holder, the license seeker already using the patent must provide adequate security, namely by providing a bank guarantee or by depositing the required amounts. In addition, the license seeker must present a precise accounting of past acts of use. If the patent infringer’s conduct does not meet these requirements, or if it employs delay tactics, an allegation of abuse of dominant position against the patent holder would not apply.

As a result, there is no FRAND determination under Huawei. The CJEU did not attempt to specify the content of FRAND, but instead crafted a negotiation framework with mutual obligations for the SEP holder and potential licensees. The goal was to bring parties back to the negotiation table, using the threats of antitrust liability and intellectual-property enforcement as levers to reach a mutually agreeable FRAND royalty level and, ultimately, to avoid a third-party determination. Further, recognizing the existence of different FRAND conditions is implicit in the back-and-forth dialectic of Huawei etiquette. By allowing parties to make diverging FRAND offers and counteroffers, the CJEU acknowledged that there is no unambiguous FRAND point and that several distributional FRAND prices may exist. Therefore, FRAND comprises a range of terms. After all, it is unclear how a rule establishing there could be just one “true” FRAND rate would help parties to negotiate successfully, while identifying a range of legitimate FRAND terms confers on the parties significant and desirable flexibility.[45]

In summary, instead of the methodological approach deployed in the United States, which is concerned with developing tools that allow courts to define royalty rates, the European approach relies on a set of conditions that assess the licensing parties’ FRAND compliance during the negotiations, in order ultimately to leave the actual determination of FRAND rates to the parties themselves.[46] The goal of such an approach is to yield economically efficient royalty rates,[47] and that goal is shared by the European Commission. Indeed, in the 2017 communication on “Setting out the EU approach to Standard Essential Patents,” the Commission stated that the parties are “best placed to arrive at a common understanding of what are fair licensing conditions and fair rates, through good faith negotiations,” and that “there is no one-size-fits-all solution to what FRAND is,” since what can be considered fair and reasonable differs from sector to sector and over time.[48]

1. The Commission’s Assessment of Huawei

In its SEP proposal, the European Commission appears to agree with the Huawei decision’s premise that the relevant parties are best-positioned to determine the terms most appropriate for their specific situation.[49] According to the Commission, however, Huawei has proven inadequate to handle the complexities of SEP-licensing negotiations. as both licensing and enforcement remain inefficient.[50]

Notably, the Commission observes that national courts have adopted differing approaches to FRAND determinations and the process for negotiating FRAND terms and conditions—in particular, with regard to certain specific aspects of the Huawei test.[51] As affirmed in the study that informed the Commission’s Impact Assessment, despite the Huawei procedural framework’s added value of legal certainty, the Commission believes many uncertainties remain and that the framework fails to resolve several contentious debates regarding the scope and content of FRAND obligations, which has, in turn, led national courts to divergent interpretations of the various steps.[52] The Commission therefore justifies its intervention at the EU level by arguing that approaches taken by member states could diverge “partly depending on whether businesses in those Member States are predominantly SEP holders or implementers.”[53]

Few would dispute that the CJEU left a number of issues unresolved in Huawei (e.g., the existence of dominant position with respect to SEPs, the possibility of applying the framework to non-practicing entities, the definition of FRAND terms) and national courts, especially in Germany, have been busy filling those gaps.[54] Diverging approaches have sometimes been adopted, in particular with regard to implementation of the parties’ duties. Among these are determining the proper order to follow in scrutinizing the FRAND nature of offers and counteroffers; the timing and basis for counteroffers; and the ways in which implementers are expected to behave to demonstrate their willingness to strike a deal. But over the years that Huawei has been implemented, national courts have performed their roles effectively, tackling the risks of both hold-up and hold-out, and untangling various contentious questions about SEPs.[55]

Moreover, empirical evidence does not support the Commission’s findings. Indeed, as already noted, inputs provided to the Impact Assessment found that the volume of SEP-litigation cases has been stable in Europe and represent only a very small proportion of patent disputes overall. There is also no evidence that SEP-licensing conditions systematically suppress or delay standards implementation, thus inducing parties to opt out from standards-related innovation.[56]

Other data further contradict the Commission’s narrative. Discrepancies among national interpretations do not appear particularly significant, as the bulk of SEP disputes are litigated in just one member state (i.e., Germany).[57] The same applies to the suspicion that diverging interpretations may reflect the geographical concentration of SEP holders, since around 80% of all SEPs held by EU companies are owned by just two companies (i.e., Nokia and Ericsson), which are established in Finland and Sweden respectively.[58]

IV.   Co-Living Dangerously

The SEP proposal’s FRAND determinations are supposed to coexist with the Huawei bargaining framework. The Commission has been keen to point out that the initiative will “neither interpret the CJEU case law nor adopt methodologies for FRAND determination per se,”[59] and that the conciliation procedure “will complement and not replace the Huawei v ZTE process.”[60] Moreover, according to the Commission, as the proposal “will establish mechanisms that promote the necessary transparency, increase certainty and reduce the potential for inconsistent rulings,” this will be “a significant improvement in the courts’ abilities to handle SEP disputes.”[61] These statements are hard to believe, however, as the rationale for the conciliation process is to replace national courts in implementing Huawei, and the approach the proposal takes is at odds with Huawei.

The Commission seeks to justify the new procedure on grounds that it is needed to address purported uncertainties stemming from diverging national applications of the Huawei procedural framework that, the Commission contends, make it unfit to ensure an efficient SEP-licensing and enforcement ecosystem. Therefore, to prevent or at least limit divergent interpretations, the conciliator would act as a more informed and presumably wiser judge. Indeed, the SEP proposal’s implicit assumption is that conciliators would have greater expertise than courts and would succeed where they have failed. As a consequence, the conciliator will examine the parties’ offers and counteroffers, and consider the Huawei negotiation steps.[62] Further, its final report will contain a summary of the process and include that information needed to assess whether the SEP holder engaged in the Huawei process with an implementer.[63] Moreover, the conciliator’s suggested FRAND royalty could also be used by both SEP holders and implementers to determine the appropriate amount of security the implementer needs to provide under Huawei.[64]

But ultimately, the SEP proposal endorses an anti-injunction approach inconsistent with the CJEU’s stance. In Huawei, the CJEU attempted to strike a fair balance among the relevant interests. Toward this aim, as the SEP proposal notes, the CJEU recognized SEP holders’ right to seek to enforce its patents in national courts.[65] The CJEU acknowledged that the exercise of remedies to protect intellectual-property rights may be considered unlawful for the purposes of competition law only in exceptional circumstances, and subordinated any limitation of injunctions to the demonstration of the licensee’s willingness to sign a FRAND deal.

In contrast, under the SEP proposal, injunctive relief would become unavailable by default and patent holders would be restricted from filing an infringement suit prior to initiating a FRAND determination, regardless of implementers’ willingness. Implementers, meanwhile, would remain free to request determinations of invalidity, as well as declarations of noninfringement and non-essentiality. Indeed, the FRAND determination would also be carried out even if the implementer failed to provide appropriate security, as required under Huawei.

As a result, in contrast to the CJEU’s approach, the SEP proposal would create an imbalance and an uneven bargaining position between licensors and license seekers. Rather than tackling both hold-up and hold-out opportunistic behavior, the Commission appears concerned only about the former—holding that the ability to negotiate a FRAND rate “without the threat of an injunction is important for any implementer.”[66] The only measure proposed to balance the obligations on both sides would be the issuance of provisional injunctions of a financial nature against the alleged infringer, which would ostensibly provide SEP holders who have agreed to license their SEPs on FRAND terms with the necessary judicial protection.[67] This right to an “injunction” would, however, preclude seizing the alleged infringer’s property, including the seizure or delivery of products suspected of infringing a SEP. Moreover, in determining whether a provisional injunction of a financial nature is adequate, the proposal suggests considering, among other things, the applicant’s economic capacity—in particular for small and medium-sized enterprises (SMEs)—in order to prevent abusive use of such a measure.[68]

While it is highly doubtful that the proposed provisional injunctions would discourage hold-out, the conciliation mechanism does not provide any measure that would offer implementers incentives to reach an agreement and accept the results. In addition to being nonbinding, the SEP proposal establishes that the FRAND determination procedure may take as long as nine months, thus potentially granting implementers the ability to benefit from a delay of patent holders’ requests for injunctive relief against infringement.

As reported by the Impact Assessment, SEP holders who responded during the public consultation identified their main problem as being the various reasons used by implementers to delay taking up a license.[69] In this regard, the conciliation process’ nine-month timeframe should be added to the long negotiations that SEP holders already face, as well as the time spent on potential litigation.[70] While the mandatory conciliation procedure would greater expose SEP holders to opportunistic conduct by implementers, the latter would be able to take advantage of further delays without losing any leverage. Indeed, given that the FRAND determination is nonbinding, implementers that pursue hold-out tactics might simply wait until SEP owners complete the process and, if dissatisfied with the outcome, challenge the results.[71]

1. New Between the Commission and German Courts

Reconciling the different approaches taken by the SEP proposal and the Huawei framework will prove particularly interesting in Germany. Since the majority of SEP disputes in the EU are litigated there, the Huawei framework has primarily implemented by German courts.[72] Hence, it is evident that any reference to divergent interpretations at the national level mainly points in the direction of Germany. Indeed, the Commission mentions German case law several times with regard to disagreements and controversies over FRAND terms and conditions.[73]

Further, and more importantly, the Commission’s concern regarding the impact of injunctions on implementers (i.e., the risk that the mere threat of an injunction may place undue pressure on negotiations and force the potential licensee to accept non-FRAND rates) is in striking contrast with the German courts’ traditional stance. Indeed, as a result of the public consultation, the Impact Assessment reported the claims of some respondents according to which: “the national court practice increasingly favours SEP holders” and this “particularly applies in Germany after the Sisvel v. Haier decisions of Germany’s Federal Court of Justice”; “some courts have (mis)interpreted Huawei v. ZTE to impose unrealistic requirements on implementers to prove their willingness”; “injunctions for SEPs under FRAND commitment have become more readily available … in particular [because of] the decision of the Germany’s Federal Court of Justice Sisvel v. Haier.”[74] More explicitly, it is argued that the German Federal Court “effectively contradicted the CJEU’s judgement Huawei v. ZTE and brought back the Orange Book Standard … re-shift[ing] the main burden of negotiations on licensees and increase[ing] the availability of injunctions.”[75]

This background conflict between the European Commission and German courts, which predates Huawei, resurfaces in the Commission’s SEP proposal. After all, the Huawei test itself was developed in response to a request for a preliminary ruling advanced by a German court, the District Court (Landgericht) of Dusseldorf.

The CJEU ruling is usually interpreted as being opposed to the framework previously crafted by the German Federal Court of Justice (BGH) in Orange Book Standard.[76] According to the Orange Book framework, a defendant seeking to rely on a competition-law defense against an SEP holder’s claim for injunction would have to advance an unconditional license offer (i.e., the signing of a FRAND license cannot be made conditional on a court’s findings regarding infringement or the validity of the patent in question) and would be required to behave from the point of offer as if the plaintiff had accepted it. Hence, the defendant must have already paid the offered royalties, albeit in escrow.

In contrast to this approach, which allowed the competition-law defense in a very few cases, the Commission took a different stance in Motorola and Samsung. Those rulings established that infringers could avoid an injunction by stating a (rather unspecific) willingness to license and by accepting the binding determination of a third party.[77] Faced with these differing evaluation criteria endorsed by the BGH and the European Commission—which appeared one-sided in favor of patent holders and infringers, respectively—the CJEU set its own framework to pursue a novel and more balanced approach.

In the aftermath of Huawei, the Sisvel v. Haier decisions aligned German case law with the new European framework, setting the general principles according to which implementers are required to show an unequivocal and unconditional willingness to sign a FRAND license and to engage in constructive negotiations to pursue this aim. This does not, however, preclude the infringer from reserving the right to challenge the use of the license.

Because of the difficulties inherent in applying the willingness criteria in concrete example, Huawei’s case-by-case detection remains challenging, as proven by the German lower courts’ jurisprudence.[78] But despite the perception that German case law is overly friendly to patent owners, however, the attention devoted to the conduct of implementers is consistent with the principles set out by the CJEU, as Huawei revolves around the willingness of license seekers.[79]

V.     The SEP Proposal’s Uncertain Added Value

The apparent incongruity between the Commission’s SEP proposal and the existing Huawei framework raises a more general question about whether the initiative could possibly be effective, which is further underscored by the inference that the proposed FRAND-determination process is essentially a response to the German courts’ approach.

Given the differing perspectives embraced by the European Commission and German courts, it is not unreasonable to wonder to what extent the conciliator’s advisory opinion will exert any influence on courts, as the conciliation procedure is mandatory but nonbinding. Indeed, courts may simply disregard the FRAND rate proposed by the conciliator. Further, it is unclear whether courts would consider the degree of the licensee’s engagement in the conciliation procedure as a factor for the willingness assessment under Huawei.

Furthermore, the core of the SEP proposal (including the FRAND determination) would not apply to identified use cases of certain standards, or parts thereof, for which there is “sufficient evidence” that SEP-licensing negotiations on FRAND terms do not give rise to “significant difficulties or inefficiencies.”[80] Therefore, certain standards or implementations can be deemed exempt by means of a delegated act, in particular those for which there are “well established commercial relationships and licensing practices,” “such as the standards for wireless communications.”[81] The Commission offers no guidance or specifications, however, on the meaning of the terms that would justify such an important exemption.

Moreover, the newly envisaged FRAND-determination procedure closely resembles the already established alternative-dispute-resolution methods, such as the mediation of FRAND disputes offered by such organizations as the World Intellectual Property Organization (WIPO). As there is no indication that a mediation process overseen by the EUIPO would hold greater appeal to the relevant parties, a further question is raised regarding how the new process would provide additional benefits compared to the solutions already in place.

Finally, although the new regulation would apply to SEPs in-force in one or more member states, FRAND determinations will nevertheless also concern global SEP licenses, unless otherwise specified by the parties in case both parties agree to the FRAND determination or by the party that requested the continuation of the FRAND determination.[82] The EU has been concerned recently by the forum-shopping strategies some companies have undertaken, which have led to increasing requests of antisuit injunctions (ASIs)—that is, orders restraining a party from pursuing foreign proceedings or enforcing a judgment obtained in foreign proceedings.[83] This surge of ASIs and the risks related to their opportunistic use in the SEP landscape is linked to the role that certain national courts (particularly in the United States, United Kingdom, and China) have come to play in establishing themselves as de facto global licensing tribunals. In such a scenario, ASIs may represent a new and dangerous unfair practice adopted, in particular, by Chinese companies, with the support of Chinese courts and authorities. The presumed goal is to promote domestic economic interests and undervalue foreign patents by setting significantly lower FRAND rates. For these reasons, the EU has filed a case against China at the World Trade Organization (WTO) for preventing EU companies from going to foreign courts to protect their SEPs.[84]

If it is true, however, that national courts’ willingness to establish themselves as global licensing tribunals has spurred a race to the courthouse, thereby offering incentives for forum shopping and the adoption of countermeasures such as ASIs, the extraterritorial effects of the SEP proposal may contribute to such a race to the bottom among jurisdictions. Indeed, from a geopolitical perspective, the provision simply appears to be a retaliation against “certain emerging economies” that are taking a “much more aggressive approach in promoting home-grown standards and providing their industries with a competitive edge in terms of market access and technology roll-out.”[85]

All these elements call into question the added value provided by the European initiative and its effective capacity to pursue the identified objectives—namely, to achieve more transparency, predictability, and efficiency in SEPs licensing. Because of these illustrated uncertainties, the SEP proposal appears likely to add confusion and to induce licensing disputes, rather than supporting balanced and successful SEP-licensing negotiations.

VI.   Conclusion

The Huawei bargaining framework represents the EU’s distinctive approach in SEP-licensing negotiations. It revolves around the principles that the relevant parties are best-positioned to determine the terms most appropriate to their specific situation, and that the exercise of remedies to protect intellectual-property rights may be considered abusive only in exceptional circumstances. Against this background, the willing-licensee test aims to ensure a balance among the differing interests of licensors and license seekers.

Despite some points of criticism and unresolved issues, the economic literature supports the European way. By promoting cooperative solutions and thus moving the parties away from the courtroom and toward the negotiating table, the Huawei framework is more likely to result in economically efficient royalty rates than alternative approaches.

The European Commission apparently does not share this view. By imposing a mandatory conciliation procedure that would impede SEP holders from seeking injunctive reliefs and would allow implementers to further delay the attainment of a license, the SEP proposal seeks to discard Huawei. The intervention seems essentially motivated by dissatisfaction with the German courts’ interpretation and implementation of Huawei, namely with their supposed patent-owner-friendly and pro-injunction approach.

The proposed FRAND-determination procedure, however, represents a solution to a problem that does not exist. The empirical evidence informing the Commission’s initiative shows that there isn’t an SEP-litigation problem in Europe. Moreover, the proposal would just add confusion and uncertainties to the current landscape, both because of its troublesome relationship with Huawei and because some provisions—such as those granting extraterritorial effects to FRAND determinations—would favor litigation and a race to the courthouse.

If the expected added value of the SEP proposal is questionable, at best, it appears far from the Commission’s purported goal of providing “a uniform, open and predictable information and outcome on SEPs for the benefit of SEP holders, implementers and end users, at Union level.”[86]

[1] European Commission, Proposal for a Regulation of the European Parliament and of the Council on Standard Essential Patents and Amending Regulation (EU) 2017/1001, COM(2023)232.

[2] Id., Recital 2.

[3] See Group of Experts on Licensing and Valuation of Standard Essential Patents, Contribution to the Debate on SEPs, (2021) https://ec.europa.eu/docsroom/documents/45217 (all websites last visited 28 Sep. 2023); European Commission, Making the Most of the EU’s Innovative Potential. An Intellectual Property Action Plan to Support the EU’s Recovery and Resilience, COM(2020) 760 final; European Commission, Setting Out the EU approach to Standard Essential Patents, COM(2017) 712 final; European Commission, ICT Standardisation Priorities for the Digital Single Market, COM(2016) 176 final.

[4] European Commission, Intellectual Property – New Framework For Standard-Essential Patents, Call for Evidence for an Impact Assessment (2022). https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13109-Intellectual-property-new-framework-for-standard-essential-patents_en.

[5] Id.

[6] See, e.g., Centre for a Digital Society of the European University Institute, Feedback to EU Commission’s Public Consultation (2023), https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13109-Intellectual-property-new-framework-for-standard-essential-patents/F3432699_en; Christine A. Varney, Makan Delrahim, David J. Kappos, Andrei Iancu, Walter G. Copan, & Noah Joshua Phillips, Comments on European Commission’s Draft “Proposal for Regulation of the European Parliament and of the Council Establishing a Framework for Transparent Licensing of Standard Essential Patents,” (2023), available at https://ipwatchdog.com/wp-content/uploads/2023/04/Comments-on-European-Commission-Draft-SEP-Regulation-by-Former-US-Officials-1.pdf; Robin Jacob & Igor Nikolic, ICLE Feedback to EU Commission’s Public Consultation, International Center for Law & Economics (2023). https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13109-Intellectual-property-new-framework-for-standard-essential-patents/F3433917_en.

[7] European Commission, Impact Assessment Report Accompanying the Document Proposal for a Regulation of the European Parliament and of the Council on Standard Essential Patents and Amending Regulation (EU) 2017/1001, SWD(2023) 124 final.

[8] Justus Baron, Pere Arque-Castells, Amandine Leonard, Tim Pohlmann, & Eric Sergheraert, Empirical Assessment of Potential Challenges in SEP Licensing, Study for the European Commission (2023), available at https://www.iplytics.com/wp-content/uploads/2023/04/Empirical-Assessment-of-Potential-Challenges-in-SEP-Licensing.pdf.

[9] Impact Assessment, supra note 7, 11-17 and 25.

[10] Baron, Arque-Castells, Leonard, Pohlmann, & Sergheraert, supra note 8, 108.

[11] Id., 109-110.

[12] Id., 185.

[13] Id., 164.

[14] SEP Proposal, supra note 1, Article 3.

[15] Varney, Delrahim, Kappos, Iancu, Copan, & Phillips, supra note 6.

[16] SEP Proposal, supra note 1, Title VI.

[17] CJEU, 16 July 2015, Case C-170/13, Huawei Technologies Co Ltd v. ZTE Corp, ECLI:EU:C:2015:477.

[18] Impact Assessment, supra note 7, 43 and 58.

[19] European Commission, 29 April 2014, Cases AT.39985 and AT.39939.

[20] Bundesgerichtshof (BGH), 6 May 2009, Case KZR 39/06.

[21] SEP Proposal, Explanatory Memorandum, supra note 1, 4; European Commission, supra note 4, 3.

[22] Baron, Arque-Castells, Leonard, Pohlmann, & Sergheraert, supra note 8, 71-73.

[23] Impact Assessment, supra note 7, 154 and 158. See also BMW Group, Feedback to EU Commission’s Public Consultation (2023), https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13109-Intellectual-property-new-framework-for-standard-essential-patents/F3434362_en; Mercedes-Benz Group, Feedback to EU Commission’s Public Consultation (2023), https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13109-Intellectual-property-new-framework-for-standard-essential-patents/F3430251_en; and Volkswagen, Feedback to EU Commission’s Public Consultation (2023), https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13109-Intellectual-property-new-framework-for-standard-essential-patents/F3430555_en (welcoming the SEP Proposal for ensuring that, parallel to FRAND determination, any filed proceedings are suspended and that no injunction request may be brought before national courts, “particularly in Germany”); Baron, Arque-Castells, Leonard, Pohlmann, & Sergheraert, supra note 8, 96 (arguing that German courts are relatively strict on the interpretation of the Huawei step regarding the assessment of whether the response has been expressed diligently and without engaging in delaying tactics).

[24] SEP Proposal, supra note 1, Recital 8 and Article 38(6).

[25] Impact Assessment, supra note 7, 15 and 51-52.

[26] SEP Proposal, supra note 1, Recital 32; See Impact Assessment, supra note 7, 43-44 (estimating that the total cost of a conciliation will be eight times lower than the average SEP court cost and that up to 24 court cases could be avoided).

[27] SEP Proposal, supra note 1, Article 39.

[28] Id., Article 34.

[29] Id., Article 56(4).

[30] Id., Article 1(3-4).

[31] Id., Article 34(4).

[32] Id., Recital 34.

[33] Id., Article 38.

[34] Id., Article 46.

[35] Id., Article 47.

[36] Id., Article 37.

[37] Id., Articles 50-58.

[38] Huawei, supra note 17.

[39] European Commission, Guidelines on the Applicability of Article 101 of the Treaty on the Functioning of the European Union to Horizontal Cooperation Agreements, C/2023/4752, (2023) OJ C 259/1, Chapter 7.

[40] Huawei, supra note 17, para. 55

[41] Id., para. 42.

[42] Id., para. 47.

[43] CJEU, 6 April 1995, Joined Cases C-241/91 P and 242/91 P, RTE and ITP v. Commission, ECLI:EU:C:1995:98; CJEU, 26 November 1998, Case C-7/97, Oscar Bronner GmbH & Co. KG v. Mediaprint Zeitungs- und Zeitschriftenverlag GmbH & Co. KG, Mediaprint Zeitungsvertriebsgesellschaft mbH & Co. KG and Mediaprint Anzeigengesellschaft mbH & Co. KG, ECLI:EU:C:1998:569; CJEU, 29 April 2004, Case C-418/01, IMS Health v. NDC Health, ECLI:EU:C:2004:257; General Court, 17 September 2007, Case T-201/04, Microsoft v. Commission ECLI:EU:T:2007:289.

[44] Huawei, supra note 17, paras. 49 and 51.

[45] See, e.g., UK Court of Appeal, Unwired Planet [2018] EWCA Civ 2344 (overturning the single FRAND rate definition endorsed by Justice Colin Birss in Unwired Planet [2017] EWHC 1304 (Pat) and stating that the economic evidence does not support such an inflexible approach and that it is unrealistic to suggest that two parties, acting fairly and reasonably, will necessarily arrive at precisely the same set of license terms as two other parties, also acting fairly and reasonably and faced with the same set of circumstances).

[46] See Chryssoula Pentheroudakis & Justus A. Baron, Licensing Terms of Standard Essential Patents: A Comprehensive Analysis of Cases, JRC Science for Policy Report (2017), 123-124, https://publications.jrc.ec.europa.eu/repository/handle/JRC104068 (arguing that, in order to determine a single royalty rate within a hypothetical negotiation framework, U.S. courts are methodologically sophisticated when they approach FRAND, while European courts are more reluctant to define a single royalty rate and instead focus on the conduct of the parties during the bilateral negotiations to assess whether they complied with the specific FRAND commitments made prior to awarding injunctions).

[47] Id., 13 and 165 (arguing that the theoretical concepts behind FRAND and the empirical data available to determine FRAND rates for specific patents and products merely allow for the determination of a potentially broad FRAND range, rather than a unique FRAND rate, thus suggesting that implementation of the FRAND range should not seek to calculate a single royalty).

[48] European Commission, supra note 3, 6.

[49] See SEP Proposal, supra note 1, Recital 31 (stating that the regulation’s primary objective is to facilitate negotiations and out-of-court dispute resolution).

[50] European Commission, supra note 4, 3.

[51] SEP Proposal, Explanatory Memorandum, supra note 1, 4-5; European Commission, supra note 4, 3.

[52] Baron, Arque-Castells, Leonard, Pohlmann, & Sergheraert, supra note 8, 58-59 and 96.

[53] European Commission, supra note 4, 3.

[54] For analysis of the German case law, see Andrea Aguggia & Giuseppe Colangelo, SEPs Infringement and Competition Law Defence in German Case Law, Queen Mary Journal of Intellectual Property (forthcoming); Giuseppe Colangelo & Valerio Torti, Filling Huawei’s Gaps: The Recent German Case Law on Standard Essential Patents, 38 European Competition Law Review 538 (2017).

[55] See Jacob & Nikolic, supra note 6 (referring, e.g., to the guidance provided regarding what the FRAND rate between the parties ought to be, the scope of a FRAND license, the meaning of a FRAND commitment’s non-discrimination requirements, and whether FRAND commitments require SEP owners to offer licenses at different levels of the production chain); see also Adam Mossoff, Feedback to EU Commission’s Public Consultation (2023), https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13109-Intellectual-property-new-framework-for-standard-essential-patents/F3434471_en.

[56] Baron, Arque-Castells, Leonard, Pohlmann, & Sergheraert, supra note 8, 108 and 164.

[57] Id., 71-73.

[58] Impact Assessment, supra note 7, 8.

[59] SEP Proposal, Explanatory Memorandum, supra note 1, 5.

[60] Impact Assessment, supra note 7, 58.

[61] SEP Proposal, Explanatory Memorandum, supra note 1, 5.

[62] Impact Assessment, supra note 7, 32.

[63] Id., 42.

[64] Id.

[65] SEP Proposal, Explanatory Memorandum, supra note 1, 3.

[66] Impact Assessment, supra note 7, 42; see also Apple, Feedback to EU Commission’s Public Consultation, (2023) 3, https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13109-Proprieta-intellettuale-nuovo-quadro-per-i-brevetti-essenziali/F3434446_it (arguing that, if properly developed and implemented, the conciliation would limit SEP holders’ ability to use injunction threats to hold up licensees and coerce above-FRAND royalties).

[67] SEP Proposal, supra note 1, Recital 35 and Article 34(4).

[68] Id., Recital 35.

[69] Impact Assessment, supra note 7, 12.

[70] Id. (reporting the findings of the study conducted by Baron, Arque-Castells, Leonard, Pohlmann, & Sergheraert, supra note 8, 145, according to which negotiations amount, on average, to three years and that litigation may add another 2.5 years).

[71] Igor Nikolic, Some Practical and Competition Concerns with the Proposed Regulation on Standard Essential Patents, 4iP Council EU AISBL (2023) 5, https://www.4ipcouncil.com/research/some-practical-and-competition-concerns-proposed-regulation-standard-essential-patents.

[72] Impact Assessment, supra note 7, 58.

[73] See, e.g., European Commission, supra note 4, 3; Impact Assessment, supra note 7, 154 and 158; SEP Proposal, Explanatory Memorandum, supra note 1, 4. See also Baron, Arque-Castells, Leonard, Pohlmann, & Sergheraert, supra note 8, 59 (arguing that, in many member states, there currently are only a limited number of decisions under Huawei and that, in light of the controversies and diverging court approaches observed in Germany, it may be difficult for parties to SEP-licensing negotiations to predict how the courts of these EU member states would decide).

[74] Impact Assessment, supra note 7, 154, 155, and 158. The reference is to BGH, 5 May 2020, Case KZR 36/17, Sisvel v. Haier (Einwand I) and BGH, 24 November 2020, Case KZR 35/17, Sisvel v. Haier (Einwand II).

[75] Impact Assessment, supra note 7, 158.

[76] Supra note 20.

[77] Supra note 19.

[78] See Aguggia & Colangelo, supra note 54.

[79] Id.

[80] SEP Proposal, supra note 1, Article 1(4).

[81] Id., Recital 4.

[82] Id., Article 38(6).

[83] For a comparative analysis, see Giuseppe Colangelo & Valerio Torti, Anti-suit Injunctions and Geopolitics in Transnational SEPs Litigation, 14 European Journal of Legal Studies 45 (2022).

[84] European Commission, EU Challenges China at the WTO to Defend its High-Tech Sector, (2022) https://ec.europa.eu/commission/presscorner/detail/en/ip_22_1103.

[85] SEP Proposal, Explanatory Memorandum, supra note 1, 2.

[86] Id., 10.

I.       Introduction

Proposals to protect children and teens online are among the few issues in recent years to receive at least rhetorical bipartisan support at both the national and state level. Citing findings of alleged psychological harm to teen users,[1] legislators from around the country have moved to pass bills that would require age verification and verifiable parental consent for teens to use social-media platforms.[2] But the primary question these proposals raise is whether such laws will lead to greater parental supervision and protection for teen users, or whether they will backfire and lead teens to become less likely to use the covered platforms altogether.

The answer, this issue brief proposes, is to focus on transaction costs.[3] Or more precisely, the answer can be found by examining how transaction costs operate under the Coase theorem.

The major U.S. Supreme Court cases that have considered laws to protect children by way of parental consent and age verification all cast significant doubt on the constitutionality of such regimes under the First Amendment. The reasoning such cases have employed appears to apply a Coasean transaction-cost/least-cost-avoider analysis, especially with respect to strict scrutiny’s least-restrictive-means test.

This has important implications for recent attempts to protect teens online by way of an imposed duty of care, mandatory age verification, and/or verifiable parental consent. First, because it means these solutions are likely unconstitutional. Second, because a least-cost-avoider analysis suggests that parents are in best positioned to help teens assess the marginal costs and benefits of social media, by way of the power of the purse and through available technological means. Placing the full burden of externalities on social-media companies would reduce the options available to parents and teens, who could be excluded altogether if transaction costs are sufficiently large as to foreclose negotiation among the parties. This would mean denying teens the overwhelming benefits of social-media usage.

Part II of this brief will define transaction costs and summarize the Coase theorem, with an eye toward how these concepts can help to clarify potential spillover harms and benefits arising from teens’ social-media usage. Part III will examine three major Supreme Court cases that considered earlier parental-consent and age-verification regimes enacted to restrict minors’ access to allegedly harmful content, while arguing that one throughline in the jurisprudence has been the implicit application of least-cost-avoider analysis. Part IV will argue that, even in light of how the internet ecosystem has developed, the Coase theorem’s underlying logic continues to suggest that parents and teens working together are the least-cost avoiders of harmful internet content.

Part V will analyze proposed legislation and recently enacted bills, some of which already face challenges in the federal courts, and argue that the least-cost-avoider analysis embedded in Supreme Court precedent should continue to foreclose age-verification and parental-consent laws. Part VI concludes.

II.     The Coase Theorem and Teenage Use of Social-Media Platforms

A.    The Coase Theorem Briefly Stated and Defined

The Coase theorem has been described as “the bedrock principle of modern law and economics,”[4] and the essay that initially proposed it may be the most-cited law-review article ever published.[5] Drawn from Ronald Coase’s seminal work “The Problem of Social Cost”[6] and subsequent elaborations in the literature,[7] the theorem suggests that:

1. The problem of externalities is bilateral;
2. In the absence of transaction costs, resources will be allocated efficiently, as the parties bargain to solve the externality problem;
3. In the presence of transaction costs, the initial allocation of rights does matter; and
4. In such cases, the burden of avoiding the externality’s harm should be placed on the lowest-cost avoider, while taking into consideration the total social costs of the institutional framework.

A few definitions are in order. An externality is a side effect of an activity that is not reflected in the cost of that activity—basically, what occurs when we do something whose consequences affect other people. A negative externality occurs when a third party does not like the effects of an action. When we say that such an externality is bilateral, it is to say that it takes two to tango: only when there is a conflict in the use or enjoyment of property is there an externality problem.

Transaction costs are the additional costs borne in the process of buying or selling, separate and apart from the price of the good or service itself—i.e., the costs of all actions involved in an economic transaction. Where transaction costs are present and sufficiently large, they may prevent otherwise beneficial agreements from being concluded. Institutional frameworks determine the rules of the game, including who should bear transaction costs. In order to maximize efficiency, the Coase theorem holds that the burden of avoiding negative externalities should be placed on the party or parties that can avoid them at the lowest cost.

A related and interesting literature focuses on whether the common law is efficient, and the mechanisms by which that may come to be the case.[8] Todd J. Zywicki and Edward P. Stringham argue—contra the arguments of Judge Richard Posner—that the common law’s relative efficiency is a function of the legal process itself, rather than whether judges implicitly or explicitly adopt efficiency or wealth maximization as goals.[9] Zywicki & Stringham find both demand-side and supply-side factors that tend to promote efficiency in the common law, but note that the supply-side factors (e.g., competitive courts for litigants) have changed over time in ways that may result in diminished incentives for efficiency.[10] Their central argument is that the re-litigation of inefficient rules eventually leads to the adoption of more efficient ones.[11] Efficiency itself, they argue, is also best understood as the ability to coordinate plans, rather than as wealth maximization.[12]

In contrast to common law, there is a relative paucity of literature on whether constitutional law follows a pattern of efficiency. For example, one scholar notes that citations to Coase’s work in the corpus of constitutional-law scholarship are actually exceedingly rare.[13] This brief seeks to contribute to the law & economics literature by examining how the Supreme Court appears implicitly to have adopted one version of efficiency—the least-cost-avoider principle—in its First Amendment reviews of parental-consent and age-verification laws under the compelling-government-interest and least-restrictive-means tests.

B.     Applying the Coase Theorem to Teenage Social-Media Usage

The Coase theorem’s basic insights are useful in evaluating not only legal decisions, but also legislation. Here, this means considering issues related to children and teenagers’ online social-media usage. Social-media platforms, teenage users, and their parents are the parties at-issue in this example. While social-media platforms create incredible value for their users,[14] they also arguably impose negative externalities on both teens and their parents.[15] The question here, as it was for Coase, is how to deal with those externalities.

The common-law framework of rights in this scenario is to allow minors to enter into enforceable agreements, except where they are void for public-policy reasons. As Adam Candeub points out:

Contract law is a creature of state law, and states require parental consent for minors entering all sorts of contracts for services or receiving privileges, including getting a tattoo, obtaining a driver’s license, using a tanning facility, purchasing insurance, and signing liability waivers. As a general rule, all contracts with minors are valid, but with certain exceptions they are voidable. And even though a minor can void most contracts he enters into, most jurisdictions have laws that hold a minor accountable for the benefits he received under the contract. Because children can make enforceable contracts for which parents could end up bearing responsibility, it is a reasonable regulation to require parental consent for such contracts. The few courts that have addressed the question of the enforceability of online contracts with minors have held the contracts enforceable on the receipt of the mildest benefit.[16]

Of course, many jurisdictions have passed laws requiring age-verification for various transactions prohibited to minors, such as laws for buying alcohol or tobacco,[17] obtaining driver’s licenses,[18] and buying lottery tickets or pornography.[19] Through the Children’s Online Privacy Protection Act and its regulations, the federal government also requires that online platforms obtain verifiable parental consent before they are permitted to collect certain personal information regarding children under age 13.[20]

The First Amendment, however, has been found to protect minors’ ability to receive speech, including through commercial transactions.[21] The question therefore arises: how should the law regard minors’ ability to access information on social-media platforms? In recent years, multiple jurisdictions have responded to this question by proposing or passing age-verification and parental-consent laws for teens’ social-media usage.[22]

As will be detailed below,[23] while the internet has contributed to significant reductions in transaction costs, they are still present. Thus, in order to maximize social-media platforms’ benefits while minimizing the negative externalities they impose, policymakers should endeavor to place the burden of avoiding the harms associated with teen use on the least-cost avoider. I argue that the least-cost avoider is parents and teens working together to make marginal decisions about social-media use, including by exploiting relatively low-cost practical and technological tools to avoid harmful content. The thesis of this issue brief is that this finding is consistent with the implicit Coasean reasoning in the Supreme Court’s major First Amendment cases on parental consent and age verification.

III.   Major Supreme Court Cases on Parent Consent and Age Verification

Parental-consent and age-verification laws that seek to protect minors from harmful content are not new. The Supreme Court has had occasion to review several of them, while applying First Amendment scrutiny. An interesting aspect of this line of cases is that the Court appears implicitly to have used Coasean analysis in understanding who should bear the burden of avoiding harms associated with speech platforms.

Specifically, in each case, after an initial finding that the restrictions were content-based, the Court applied strict scrutiny. Thus, the burden was placed on the government to prove the relevant laws were narrowly tailored to a compelling government interest using the least-restrictive means. The Court’s transaction-cost analysis is implicit throughout the descriptions of the problem in each case. But the main area of analysis below will be from each case’s least-restrictive-means test section, with a focus on the compelling-state-interest test in Part III.C. Parts III.A, III.B, and III.C will deal with each of these cases in turn.

A.    United States v Playboy Entertainment Group

In United States v. Playboy Entertainment Group,[24] the Supreme Court reviewed § 505 of the Telecommunications Act of 1996, which required “cable television operators who provide channels ‘primarily dedicated to sexually-oriented programming’ either to ‘fully scramble or otherwise fully block’ those channels or to limit their transmission to hours when children are unlikely to be viewing, set by administrative regulation as the time between 10 p.m. and 6 a.m.”[25] Even prior to the regulations promulgated pursuant to the law, cable operators used technological means called “scrambling” to blur sexually explicit content for those viewers who didn’t explicitly subscribe to such content, but there were reported problems with “signal bleed” that allowed some audio and visual content to be obtained by nonsubscribers.[26] Following the regulation, cable operators responded by shifting the hours when such content would be aired—i.e., by making it unavailable for 16 hours a day. This prevented cable subscribers from viewing purchased content of their choosing at times they would prefer.[27]

The basic Coasean framework is present right from the description of the problems that the statute and regulations were trying to solve. As the Court put it:

Two essential points should be understood concerning the speech at issue here. First, we shall assume that many adults themselves would find the material highly offensive; and when we consider the further circumstance that the material comes unwanted into homes where children might see or hear it against parental wishes or consent, there are legitimate reasons for regulating it. Second, all parties bring the case to us on the premise that Playboy’s programming has First Amendment protection. As this case has been litigated, it is not alleged to be obscene; adults have a constitutional right to view it; the Government disclaims any interest in preventing children from seeing or hearing it with the consent of their parents; and Playboy has concomitant rights under the First Amendment to transmit it. These points are undisputed.[28]

In Coasean language, the parties at-issue were the cable operators, content-providers of sexually explicit programming, adult cable subscribers, and their children. Cable television provides tremendous value to its customers, including sexually explicit subscription content that is valued by those subscribers. There is, however, a negative externality to the extent that such programming may become available to children whose parents find it inappropriate. The Court noted that some parents may allow their children to receive such content, and the government disclaimed an interest in preventing such reception with parental consent. Given imperfect scrambling technology, this possible negative externality was clearly present. The question that arose was whether the transaction costs imposed by time-shifting requirements in Section 505 have the effect of restricting adults’ ability to make such viewing decisions for themselves and on behalf of their children.

After concluding that Section 505 was a content-based restriction, due to the targeting of specific adult content and specific programmers, the Court stated that when a content-based restriction is designed “to shield the sensibilities of listeners, the general rule is that the right of expression prevails, even where no less restrictive alternative exists. We are expected to protect our own sensibilities ‘simply by averting [our] eyes.’” [29]

This application of strict scrutiny does not change, the court noted, because we are dealing in this instance with children or the issue of parental consent:

No one suggests the Government must be indifferent to unwanted, indecent speech that comes into the home without parental consent. The speech here, all agree, is protected speech; and the question is what standard the Government must meet in order to restrict it. As we consider a content-based regulation, the answer should be clear: The standard is strict scrutiny. This case involves speech alone; and even where speech is indecent and enters the home, the objective of shielding children does not suffice to support a blanket ban if the protection can be accomplished by a less restrictive alternative.[30]

Again, using our Coasean translator, we can read the opinion as saying the least-cost way to avoid the negative externality of unwanted adult content is by just not looking at it, or for parents to use the means available to them to prevent their children from viewing it.

In fact, that is exactly where the Court goes, by comparing, under the least-restrictive-means test, the targeted blocking mechanism made available in Section 504 of the statute to the requirements imposed by Section 505:

[T]argeted blocking enables the Government to support parental authority without affecting the First Amendment interests of speakers and willing listeners—listeners for whom, if the speech is unpopular or indecent, the privacy of their own homes may be the optimal place of receipt. Simply put, targeted blocking is less restrictive than banning, and the Government cannot ban speech if targeted blocking is a feasible and effective means of furthering its compelling interests. This is not to say that the absence of an effective blocking mechanism will in all cases suffice to support a law restricting the speech in question; but if a less restrictive means is available for the Government to achieve its goals, the Government must use it.[31]

Moreover, the Court found that the fact that parents largely eschewed the available low-cost means to avoid the harm was not necessarily sufficient for the government to prove that it is the least-restrictive alternative:

When a plausible, less restrictive alternative is offered to a content-based speech restriction, it is the Government’s obligation to prove that the alternative will be ineffective to achieve its goals. The Government has not met that burden here. In support of its position, the Government cites empirical evidence showing that § 504, as promulgated and implemented before trial, generated few requests for household-by-household blocking. Between March 1996 and May 1997, while the Government was enjoined from enforcing § 505, § 504 remained in operation. A survey of cable operators determined that fewer than 0.5% of cable subscribers requested full blocking during that time. Id., at 712. The uncomfortable fact is that § 504 was the sole blocking regulation in effect for over a year; and the public greeted it with a collective yawn.[32]

This is because there were, in fact, other market-based means available for parents to use to avoid the harm of unwanted adult programming,[33] and the government had not proved that Section 504 could be effective with more adequate notice.[34] The Court concluded its least-restrictive means analysis by saying:

Even upon the assumption that the Government has an interest in substituting itself for informed and empowered parents, its interest is not sufficiently compelling to justify this widespread restriction on speech. The Government’s argument stems from the idea that parents do not know their children are viewing the material on a scale or frequency to cause concern, or if so, that parents do not want to take affirmative steps to block it and their decisions are to be superseded. The assumptions have not been established; and in any event the assumptions apply only in a regime where the option of blocking has not been explained. The whole point of a publicized § 504 would be to advise parents that indecent material may be shown and to afford them an opportunity to block it at all times, even when they are not at home and even after 10 p.m. Time channeling does not offer this assistance. The regulatory alternative of a publicized § 504, which has the real possibility of promoting more open disclosure and the choice of an effective blocking system, would provide parents the information needed to engage in active supervision. The Government has not shown that this alternative, a regime of added communication and support, would be insufficient to secure its objective, or that any overriding harm justifies its intervention.[35]

In Coasean language, the government’s imposition of transaction costs through time-shifting channels is not the least-cost way to avoid the harm. By publicizing the blocking mechanism of Section 504, as well as promoting market-based alternatives like VCRs to record programming for playback later or blue-screen technology that blocks scrambled video, adults would be able to effectively act as least-cost avoiders of harmful content, including on behalf of their children.

B.     Ashcroft v ACLU

In Ashcroft v. ACLU,[36] the Supreme Court reviewed a U.S. District Court’s preliminary injunction of the age-verification requirements imposed by the Children Online Protection Act (COPA), which was designed to “protect minors from exposure to sexually explicit materials on the Internet.”^[37] The law created criminal penalties “of a $50,000 fine and six months in prison for the knowing posting” for ‘commercial purposes’ of World Wide Web content that is ‘harmful to minors.’”[38] The law did, however, provide an escape hatch, through:

…an affirmative defense to those who employ specified means to prevent minors from gaining access to the prohibited materials on their Web site. A person may escape conviction under the statute by demonstrating that he

“has restricted access by minors to material that is harmful to minors—

“(A) by requiring use of a credit card, debit account, adult access code, or adult personal identification number;

“(B) by accepting a digital certificate that verifies age; or

“(C) by any other reasonable measures that are feasible under available technology.” § 231(c)(1).[39]

Here, the Coasean analysis of the problem is not stated as explicitly as in Playboy, but it is still apparent. The internet clearly provides substantial value to users, including those who want to view pornography. But there is a negative externality in internet pornography’s broad availability to minors for whom it would be inappropriate. Thus, to prevent these harms, COPA established a criminal regulatory scheme with an age-verification defense. The threat of criminal penalties, combined with the age-verification regime, imposed high transaction costs on online publishers who post content defined as harmful to minors. This leaves adults (including parents of children) and children themselves as the other relevant parties. Again, the question is: who is the least-cost avoider of the possible negative externality of minor access to pornography? The adult-content publisher or the parents, using technological and practical means?

The Court immediately went to an analysis of the least-restrictive-means test, defining the inquiry as follows:

In considering this question, a court assumes that certain protected speech may be regulated, and then asks what is the least restrictive alternative that can be used to achieve that goal. The purpose of the test is not to consider whether the challenged restriction has some effect in achieving Congress’ goal, regardless of the restriction it imposes. The purpose of the test is to ensure that speech is restricted no further than necessary to achieve the goal, for it is important to ensure that legitimate speech is not chilled or punished. For that reason, the test does not begin with the status quo of existing regulations, then ask whether the challenged restriction has some additional ability to achieve Congress’ legitimate interest. Any restriction on speech could be justified under that analysis. Instead, the court should ask whether the challenged regulation is the least restrictive means among available, effective alternatives.[40]

The Court then considered the available alternative to COPA’s age-verification regime: blocking and filtering software. They found that such tools are clearly less-restrictive means, focusing not only on the software’s granting parents the ability to prevent their children from accessing inappropriate material, but also that adults would retain access to any content blocked by the filter by simply turning it off.[41] In fact, the Court noted that the evidence presented to the District Court suggested that filters, while imperfect, were probably even more effective than the age-verification regime.[42] Finally, the Court noted that, even if Congress couldn’t require filtering software, it could encourage it through parental education, by providing incentives to libraries and schools to use it, and by subsidizing development of the industry itself. Each of these, the Court argued, would be clearly less-restrictive means of promoting COPA’s goals.[43]

In Coasean language, the Court found that parents using technological and practical means are the least-cost avoider of the harm of exposing children to unwanted adult content. Government promotion and support of those means were held up as clearly less-restrictive alternatives than imposing transaction costs on publishers of adult content.

C.    Brown v Entertainment Merchants Association

In Brown v. Entertainment Merchants Association,[44] the Court considered California Assembly Bill 1179, which prohibited the sale or rental of “violent video games” to minors.[45] The Court first disposed of the argument that the government could create a new category of speech that it considered unprotected, just because it is directed at children, stating:

The California Act is something else entirely. It does not adjust the boundaries of an existing category of unprotected speech to ensure that a definition designed for adults is not uncritically applied to children. California does not argue that it is empowered to prohibit selling offensively violent works to adults—and it is wise not to, since that is but a hair’s breadth from the argument rejected in Stevens. Instead, it wishes to create a wholly new category of content-based regulation that is permissible only for speech directed at children.

That is unprecedented and mistaken. “[M]inors are entitled to a significant measure of First Amendment protection, and only in relatively narrow and well-defined circumstances may government bar public dissemination of protected materials to them.” Erznoznik v. Jacksonville, 422 U.S. 205, 212-213, 95 S.Ct. 2736*2736 2268, 45 L.Ed.2d 125 (1975) (citation omitted). No doubt a State possesses legitimate power to protect children from harm, Ginsberg, supra, at 640-641, 88 S.Ct. 1274; Prince v. Massachusetts, 321 U.S. 158, 165, 64 S.Ct. 438, 88 L.Ed. 645 (1944), but that does not include a free-floating power to restrict the ideas to which children may be exposed. “Speech that is neither obscene as to youths nor subject to some other legitimate proscription cannot be suppressed solely to protect the young from ideas or images that a legislative body thinks unsuitable for them.” Erznoznik, supra, at 213-214, 95 S.Ct. 2268.[46]

The Court rejected that there was any “longstanding tradition” of restricting children’s access to depictions of violence, as demonstrated by copious examples of violent content in children’s books, high-school reading lists, motion pictures, radio dramas, comic books, television, music lyrics, etc. Moreover, to the extent there was a time when government enforced such regulations, the courts have eventually overturned them.[47] The fact that video games were interactive did not matter either, the Court found, as all literature is potentially interactive, especially genres like choose-your-own-adventure stories.[48]

Thus, because the law was clearly content-based, the Court applied strict scrutiny. The Court was skeptical even of whether the government had a compelling state interest, finding the law to be both seriously over- and under-inclusive. The same effects of exposure to violent content, the Court noted, could be found from covered video games and cartoons not subject to the law’s provisions. Moreover, the law allowed a parent or guardian (or any adult) to buy violent video games for their children.[49]

The Court then gets to the law’s real justification, which it summarily rejected as inconsistent with the First Amendment:

California claims that the Act is justified in aid of parental authority: By requiring that the purchase of violent video games can be made only by adults, the Act ensures that parents can decide what games are appropriate. At the outset, we note our doubts that punishing third parties for conveying protected speech to children just in case their parents disapprove of that speech is a proper governmental means of aiding parental authority.[50]

In Coasean language, the Court is saying that video games—even violent ones—are subjectively valued by those who play them, including minors. There may be negative externalities from playing such games, in that exposure to violence could be linked to psychological harm, and that they are interactive, but these content and design features are still protected speech. Placing the transaction costs on parents/adults to buy such games on behalf of minors, just in case some parents disapprove of their children playing them, is not a compelling state interest.

While the Court is only truly focused on whether there is a compelling state interest in California’s statutory scheme regulating violent video games, some of the language would equally apply to a least-restrictive means analysis:

But leaving that aside, California cannot show that the Act’s restrictions meet a substantial need of parents who wish to restrict their children’s access to violent video games but cannot do so. The video-game industry has in place a voluntary rating system designed to inform consumers about the content of games. The system, implemented by the Entertainment Software Rating Board (ESRB), assigns age-specific ratings to each video game submitted: EC (Early Childhood); E (Everyone); E10 + (Everyone 10 and older); T (Teens); M (17 and older); and AO (Adults Only—18 and older). App. 86. The Video Software Dealers Association encourages retailers to prominently display information about the ESRB system in their stores; to refrain from renting or selling adults-only games to minors; and to rent or sell “M” rated games to minors only with parental consent. Id., at 47. In 2009, the Federal Trade Commission (FTC) found that, as a result of this system, “the video game industry outpaces the movie and music industries” in “(1) restricting target-marketing of mature-rated products to children; (2) clearly and prominently disclosing rating information; and (3) restricting children’s access to mature-rated products at retail.” FTC, Report to Congress, Marketing Violent Entertainment to Children 30 (Dec.2009), online at http://www. ftc.gov/os/2009/12/P994511violent entertainment.pdf (as visited June 24, 2011, and available in Clerk of Court’s case file) (FTC Report). This system does much to ensure that minors cannot purchase seriously violent games on their own, and that parents who care about the matter can readily evaluate the games their children bring home. Filling the remaining modest gap in concerned parents’ control can hardly be a compelling state interest.

And finally, the Act’s purported aid to parental authority is vastly overinclusive. Not all of the children who are forbidden to purchase violent video games on their own have parents who care whether they purchase violent video games. While some of the legislation’s effect may indeed be in support of what some parents of the restricted children actually want, its entire effect is only in support of what the State thinks parents ought to want. This is not the narrow tailoring to “assisting parents” that restriction of First Amendment rights requires.[51]

In sum, the Court suggests that the law would not be narrowly tailored, because there are already market-based systems in place to help parents and minors make informed decisions about which video games to buy—most importantly from the rating system that judges appropriateness by age and offers warnings about violence. Government paternalism is simply insufficient to justify imposing new transaction costs on parents and minors who wish to buy even violent video games.

Interestingly, the concurrence of Justice Samuel Alito, joined by Chief Justice John Roberts, also contains some language that could be interpreted through a Coasean lens. The concurrence allows, in particular, the possibility that harms from interactive violent video games may differ from other depictions of violence that society has allowed children to view, although it concludes that reasonable minds may differ.[52] In other words, the concurrence basically notes that the negative externalities may be greater than the majority opinion would allow, but nonetheless, that Justices Alito and Roberts agreed the law was not drafted in a constitutional manner that comports with the obscenity exception to the First Amendment.

Nonetheless, it appears the Court applies an implicit Coasean framework when it rejects the imposition of transaction costs on parents and minors to gain access to protected speech—in this case, violent video games. Parents and minors remain the least-cost avoiders of the potential harms of violent video games.

IV.   Coase Theorem Applied to Age-Verification and Verifiable-Consent Laws

As outlined above, the issue is whether social media needs age-verification and parental-consent laws in order to address negative externalities to minor users. This section will analyze this question under the Coasean framework introduced in Part II.

The basic argument proceeds as follows:

1. Transaction costs for age verification and verifiable consent from parents and/or teens are sufficient large to prevent a bargain from being struck;
2. The lowest-cost avoiders are parents and teens working together, using practical and technological means, including low-cost monitoring and filtering services, to make marginal decisions about minors’ social-media use; and
3. Placing the transaction costs on social-media companies to obtain age verification and verifiable consent from parents and/or teens would actually reduce their ability to make marginal decisions about minors’ social-media use, as social-media companies will respond by investing more in excluding minors from access than in creating safe and vibrant spaces for interaction.

Part IV.A will detail the substantial transaction costs associated with obtaining age verification and verifiable parental consent. Part IV.B argues that parents and teens working together using practical and technological means are the lowest-cost avoiders of the harms of social-media use. Part IV.C will consider the counterfactual scenario of placing the transaction costs on social-media companies and argue that the result would be teens’ exclusion from social media, to their detriment, as well as the detriment of parents who would have made different choices.

A.    Transaction Costs, Age Verification, and Verifiable Parental Consent[53]

As Coase taught, in a world without transaction costs (or where such costs are sufficiently low), age-verification laws or mandates to obtain verifiable parental consent would not matter, because the parties would bargain to arrive at an efficient solution. Because there are high transaction costs that prevent such bargains from being easily struck, making the default that teens cannot join social media without verifiable parental consent could have the effect of excluding them from the great benefits of social media usage altogether.[54]

There is considerable evidence that, even despite the internet and digital technology serving to reduce transaction costs considerably across a wide range of fronts,[55] transaction costs remain high when it comes to age verification and verifiable parental consent. A data point that supports this conclusion is the experience of social-media platforms under the Children’s Online Privacy Protection Act (COPPA).[56] In their working paper “COPPAcalypse? The YouTube Settlement’s Impact on Kids Content,”[57] Garrett Johnson, Tesary Lin, James C. Cooper, & Liang Zhong summarized the issue as follows:

The Children’s Online Privacy Protection Act (COPPA), and its implementing regulations, broadly prohibit operators of online services directed at children under 13 from collecting personal information without providing notice of its data collection and use practices and obtaining verifiable parental consent. Because obtaining verifiable parental consent for free online services is difficult and rarely cost justified, COPPA essentially acts as a de facto ban on the collection of personal information by providers of free child-directed content. In 2013, the FTC amended the COPPA rules to include in the definition of personal information “persistent identifier that can be used to recognize a user over time and across different Web sites or online services,” such as a “customer number held in a cookie . . . or unique device identifier.” This regulatory change meant that, as a practical matter, online operators who provide child-directed content could no longer engage in personalized advertising.

On September 4, 2019, the FTC entered into a consent agreement with YouTube to settle charges that it had violated COPPA. The FTC’s allegations focused on YouTube’s practice of serving personalized advertising on child-directed content at children without obtaining verifiable parental consent. Although YouTube maintains it is a general audience website and users must be at least 13 years old to obtain a Google ID (which makes personalized advertising possible), the FTC complaint alleges that YouTube knew that many of its channels were popular with children under 13, citing YouTube’s own claims to advertisers. The settlement required YouTube to identify child-directed channels and videos and to stop collecting personal information from visitors to these channels. In response, YouTube required channel owners producing [“made-for-kids”] MFK content to designate either their entire channels or specific videos as MFK, beginning on January 1, 2020. YouTube supplemented these self-designations with an automated classifier designed to identify content that was likely directed at children younger than 13.9 In so doing, YouTube effectively shifted liability under COPPA to the channel owners, who could face up to $42,530 in fines per video if they fail to self-designate and are not detected by YouTube’s classifier.[58]

The rule change and settlement increased the transaction costs imposed on social-media platforms by requiring verifiable parental consent. YouTube’s economically rational response was to restrict the content creators’ ability to benefit from (considerably more lucrative) personalized advertising. The end result was less content created for children, with competitive effects to boot:

Consistent with a loss in personalized ad revenue, we find that child-directed content creators produce 13% less content and pivot towards producing non-child-directed content. On the demand side, views of child-directed channels fall by 22%. Consistent with the platform’s degraded capacity to match viewers to content, we find that content creation and content views become more concentrated among top child-directed YouTube channels.[59]

This is not the only finding regarding COPPA’s role in reducing the production of content for children. The president of the App Association, a global trade association for small and medium-sized technology companies, presented extensively at the Federal Trade Commission’s (FTC) 2019 COPPA Workshop.[60] The testimony from App Association President Morgan Reed detailed that the transaction costs associated with obtaining verifiable parental consent did little to enhance parental control, but much to reduce the quality and quantity of content directed to children. But it is worth highlighting Reed’s constant use of the words “friction,” “restriction,” and “cost” to describe how the institutional environment of COPPA affects the behavior of the social media platforms, parents, and children. While noting that general audience content is “unfettered, meaning that you don’t feel restricted by what you can get to, how you do it. It’s easy, it’s low friction. Widely available. I can get it on any platform, in any case, in any context and I can get to it rapidly,” COPPA-regulated apps and content are, Reed said, all about:

Friction, restriction, and cost. Every layer of friction you add alters parent behavior significantly. We jokingly refer to it as the over the shoulder factor. If a parent wants access to something and they have to pass it from the back seat to the front seat of the car more than one time, the parent moves on to the next thing. So the more friction you add to an application directed at children the less likely it is that the parent is going to take the steps necessary to get through it because the competition, of course, is as I said, free, unfettered, widely available. Restriction. Kids balk against some of the restrictions. I can’t get to this, I can’t do that. And they say that to the parent. And from the parent’s perspective, fine, I’ll just put in a different age date. They’re participating, they’re parenting but they’re not using the regulatory construction that we all understand. …

The COPPA side, expensive, onerous or friction full. We have to find some way around that. Restrictive, fewer features, fewer capabilities, less known or available, and it’s entertaining-ish. …

Is COPPA the barrier? I thought this quote really summed it up. “Seamlessness is expected. But with COPPA, seamlessness is impossible.” And that has been one of the single largest areas of concern. Our folks are looking to provide a COPPA compliant environment. And they’re finding doing VPC is really hard. We want to make it this way, we just walked away. And why do they want to do it? We wanted to create a hub for kids to promote creativity. So these are not folks who are looking to take data and provide interest based advertising. They’re trying to figure out how to do it so they can build an engaging product. Parental consent makes the whole process very complicated. And this is the depressing part. …

We say that VPC is intentional friction. It’s clear from everything we’ve heard in the last two panels that the authors of COPPA, we don’t really want information collected on kids. So friction is intentional. And this is leading to the destruction of general audience applications basically wiping out COPPA apps off the face of the map.[61]

Reed’s use of the word “friction” is particularly enlightening. Mike Munger has often described transaction costs as frictions, explaining that, to consumers, all costs are transaction costs.[62] When higher transaction costs are imposed on social-media platforms, end users feel the impact. In this case, the result is that children and parents receive less quality children’s apps and content.

A similar example can be seen in the various battles between traditional media and social-media companies in Australia, Canada, and the EU, where laws have been passed that would require platforms to pay for linking to certain news content.[63] Because these laws raise transaction costs, social-media platforms have responded by restricting access to news links,[64] to the detriment of users and the news-media organizations themselves. In other words, much like with verifiable parental consent, the intent of these laws is thwarted by the underlying economics.

More evidence that imposing transaction costs on social-media companies can have the effect of diminishing the user experience can be found in the preliminary injunction issued by the U.S. District Court in Austin, Texas in Free Speech Coalition Inc. v. Colmenero.[65] The court cited evidence from the plaintiff’s complaint that included bills for “several commercial verification services, showing that they cost, at minimum, $40,000.00 per 100,000 verifications.”[66] The court also noted that “[Texas law] H.B. 1181 imposes substantial liability for violations, including $10,000.00 per day for each violation, and up to $250,000.00 if a minor is shown to have viewed the adult content.”[67]

Moreover, the transaction costs in this example also include the subjective costs borne by those who actually go through with verifying their age to access pornography. As the court noted “the law interferes with the Adult Video Companies’ ability to conduct business, and risks deterring adults from visiting the websites.”[68] The court issued a preliminary injunction against the law’s age-verification provision, finding that other means—such as content-filtering software—are clearly more effective than age verification to protect children from unwanted content.[69]

In sum, transaction costs for age verification and verifiable parental consent are sufficiently high as to prevent an easy bargain from being struck. Thus, which party bears the burden of those costs will determine the outcome. The lessons from COPPA, news-media laws, and online-pornography age-verification laws are clear: if the transaction costs are imposed on the online platforms and apps, it will lead to access restrictions on the speech those platforms provide, almost all of which is protected speech. This is the type of collateral censorship that the First Amendment is designed to avoid.[70]

B.     Parents and Teens as the Least-Cost Avoiders of Negative Externalities

If transaction costs due to online age-verification and verifiable-parent-consent laws are substantial, the question becomes which party or parties should be subject to the burden of avoiding the harms arising from social-media usage.

It is possible, in theory, that social-media platforms are the best-positioned to monitor and control content posted to their platforms—for instance, when it comes to harms associated with anonymous or pseudonymous accounts imposing social costs on society.[71] In such cases, a duty of care that would allow for intermediary liability against social-media companies may make sense.[72]

On the other hand, when it comes to online age-verification and parental-consent laws, widely available practical and technological means appear to be lowest-cost way to avoid the negative externalities associated with social-media usage. As NetChoice put it in their complaint against Arkansas’ social-media age-verification law, “[p]arents have myriad ways to restrict their children’s access to online services and to keep their children safe on such services.”[73]

In their complaint, NetChoice recognizes the subjective nature of negative externalities, stating:

Just as people inevitably have different opinions about what books, television shows, and video games are appropriate for minors, people inevitably have different views about whether and to what degree online services are appropriate for minors. While many minors use online services in wholesome and productive ways, online services, like many other technologies, can be abused in ways that may harm minors.[74]

They then expertly list all the ways that parents can take control and help their children avoid online harms, including with respect to the decisions to buy devices for their children and to set terms for how and when they are permitted to use them.[75] Parents can also choose to use tools from cell-phone carriers and broadband providers to block certain apps and sites from their children’s devices, or to control with whom their children can communicate and for how long they can use the devices.[76] They also point to wireless routers that allow for parents to filter and monitor online content;[77] parental controls at the device level;[78] third-party filtering applications;[79] and numerous tools offered by NetChoice members that all allow for relatively low-cost monitoring and control by parents and even teen users acting on their own behalf.[80] Finally, they note that NetChoice members, in response to market demand,[81]expend significant resources curating content to make sure it’s appropriate.[82]

The recent response from the Australian government to the proposed “Roadmap for Age Verification”[83] buttresses this analysis. The government pulled back from plans to “force adult websites to bring in age verification following concerns about privacy and the lack of maturity of the technology.”[84] In particular, the government noted that:

It is clear from the Roadmap that at present, each type of age verification or age assurance technology comes with its own privacy, security, effectiveness and implementation issues. For age assurance to be effective, it must:

• work reliably without circumvention;
• be comprehensively implemented, including where pornography is hosted outside of Australia’s jurisdiction; and
• balance privacy and security, without introducing risks to the personal information of adults who choose to access legal pornography.

Age assurance technologies cannot yet meet all these requirements. While industry is taking steps to further develop these technologies, the Roadmap finds that the age assurance market is, at this time, immature.

The Roadmap makes clear that a decision to mandate age assurance is not ready to be taken.[85]

As a better solution, the government offered “[m]ore support and resources for families,”[86] including promoting tools already available in the marketplace to help prevent children from accessing inappropriate content like pornography,[87] and promoting education for both parents and children on how to avoid online harms.[88]

In sum, this is all about transaction costs. The least-cost avoider from negative externalities imposed by social-media usage are the parents and teens themselves, working together to make marginal decisions about how to use these platforms through the use of widely available practical and technological means.

C.    Teen Exclusion Online and Reduced Parental Involvement in Social-Media Usage Decisions

If the burden of avoiding negative externalities is placed on social-media platforms, the result could be considerable collateral censorship of protected speech. This is because of transaction costs, as explained above in Part IV.A. Thus, while one could argue that the externalities imposed by social-media platforms on teen users and their parents represent a market failure, this is not the end of the analysis. Transaction costs help to explain that the institutional environment we create fosters the rules of the game that platforms, parents, and teens follow. If transaction costs are too high and placed incorrectly on social-media platforms, parents and teens’ ability to control how they use social media will actually suffer.

As can be seen most prominently in the COPPA examples discussed above,[89] the burden of obtaining verifiable parental consent leads to platforms reallocating investments into the exclusion of the protected class—in that case, children under age 13—that could otherwise go toward creating a safe and vibrant community from which children could benefit. Thus, proposals like COPPA 2.0,[90] which would extend the need for verifiable consent to teens, could yield an equivalent result of greater exclusion of teens. State laws that would require age verification and verifiable parental consent for teens are likely to produce the same result, as well. The irony, of course, is that parental consent laws would actually reduce the available choices for those parents who see the use value for their teenagers.

In sum, the economics of transaction costs explains why age-verification and verifiable-parental-consent laws will not satisfy their proponents’ stated objectives. As with minimum-wage laws[91] and rent control,[92] economics helps to explain the counterintuitive finding that well-intentioned laws can actually produce the exact opposite end result. Here, that means age-verification and verifiable-parental-consent laws lead to parents and teens being less able to make meaningful and marginal decisions about the costs and benefits of their own social-media usage.

V.     The Unconstitutionality of Social-Media Verification and Verifiable-Consent Laws

Bringing this all together, Part V will consider the constitutionality of the enacted and proposed laws on age verification and verifiable parental consent under the First Amendment. As several courts have already suggested, these laws will not survive First Amendment scrutiny.

The first question is whether these laws will be subject to strict scrutiny (because they are content-based) or instead to intermediate scrutiny as content-neutral regulations. There is a possibility that it will not matter, because a court could find—as one already has—that such laws burden more speech than necessary anyway. Part V.A will take up these questions.

The second set of questions is whether, assuming strict scrutiny applies, these enacted and proposed laws could survive the least-restrictive-means test. Part V.B will consider this set of questions and argue that, as the lowest-cost avoiders, parents and teens working together using widely available practical and technological means to avoid negative externalities also represents the least-restrictive means to promote the government’s interest in protecting minors from the harms of social media.

A.    Questions of Content Neutrality

The first important question is whether laws that attempt to protect minors from externalities associated with social-media usage are content-neutral. One argument that has been forwarded is that they are simply content-neutral contract laws that shift the consent default to parents before teens can establish an ongoing contractual relationship with a social-media company by creating a profile.[93]

Before delving into whether that argument could work, it is worth considering laws that are clearly content-based to help tell the difference. For instance, the Texas law challenged in Free Speech Coalition v. Colmenero is clearly content-based, because “the regulation is based on whether content contains sexual material.”[94]

Similarly, laws like the Kids Online Safety Act (KOSA)[95] are content-based, in that they require covered platforms to take:

reasonable measures in its design or operation of products and services to prevent or mitigate the following:

• Consistent with evidence-informed medical information, the following mental health disorders: anxiety, depression, eating disorders, substance use disorders, and suicidal behaviors.

• Patterns of use that indicate or encourage addiction-like behaviors.

• Physical violence, online bullying, and harassment of the minor.

• Sexual exploitation and abuse.

• Promotion and marketing of narcotic drugs (as defined in section 102 of the Controlled Substances Act (21 U.S.C. 802)), tobacco products, gambling, or alcohol.

• Predatory, unfair, or deceptive marketing practices, or other financial harms.[96]

While parts 4-6 and actual physical violence all constitute either unprotected speech or conduct, decisions about how to present information from part 2 is arguably protected speech.[97] Even true threats like online bullying and harassment are speech subject to at least some First Amendment scrutiny, in that they would require some type of mens rea to be constitutional.[98] Part 1 may be unconstitutionally vague as written.[99] Moreover, 1-3 are clearly content-based, in that it is necessary to consider the content presented, which will include at least some protected speech. This equally applies to the California Age Appropriate Design Code,[100] which places an obligation on covered companies to identify and mitigate speech that is harmful or potentially harmful to users under 18 years old, and to prioritize speech that promotes such users’ well-being and best interests.[101]

In each of these cases, it would be difficult to argue that strict scrutiny ought not apply. On the other hand, some have argued that the Utah and Arkansas laws requiring age verification and verifiable parental consent are simply content-neutral regulations of contract formation, which can be considered independently of speech.[102] Arkansas has argued that Act 689’s age-verification requirements are “merely a content-neutral regulation on access to speech at particular ‘locations,’ so intermediate scrutiny should apply.”[103]

But even in NetChoice v. Griffin,[104] the U.S. District Court in Arkansas, while skeptical that the law was content-neutral,[105] proceeded as if it was and still found, in granting a preliminary injunction, that the age-verification law “is likely to unduly burden adult and minor access to constitutionally protected speech.”[106] Similarly, the U.S. District Court for the Northern District of California found that all major provisions of California’s AADC were likely unconstitutional under a lax commercial-speech standard.[107]

Nonetheless, there are strong arguments that these laws are content-based. As the court in Griffin put it:

Deciding whether Act 689 is content-based or content-neutral turns on the reasons the State gives for adopting the Act. First, the State argues that the more time a minor spends on social media, the more likely it is that the minor will suffer negative mental health outcomes, including depression and anxiety. Second, the State points out that adult sexual predators on social media seek out minors and victimize them in various ways. Therefore, to the State, a law limiting access to social media platforms based on the user’s age would be content-neutral and require only intermediate scrutiny.

On the other hand, the State points to certain speech-related content on social media that it maintains is harmful for children to view. Some of this content is not constitutionally protected speech, while other content, though potentially damaging or distressing, especially to younger minors, is likely protected nonetheless. Examples of this type of speech include depictions and discussions of violence or self-harming, information about dieting, so-called “bullying” speech, or speech targeting a speaker’s physical appearance, race or ethnicity, sexual orientation, or gender. If the State’s purpose is to restrict access to constitutionally protected speech based on the State’s belief that such speech is harmful to minors, then arguably Act 689 would be subject to strict scrutiny.

During the hearing, the State advocated for intermediate scrutiny and framed Act 689 as “a restriction on where minors can be,” emphasizing it was “not a speech restriction” but “a location restriction.” The State’s briefing analogized Act 689 to a restriction on minors entering a bar or a casino. But this analogy is weak. After all, minors have no constitutional right to consume alcohol, and the primary purpose of a bar is to serve alcohol. By contrast, the primary purpose of a social media platform is to engage in speech, and the State stipulated that social media platforms contain vast amounts of constitutionally protected speech for both adults and minors. Furthermore, Act 689 imposes much broader “location restrictions” than a bar does. The Court inquired of the State why minors should be barred from accessing entire social media platforms, even though only some of the content was potentially harmful to them, and the following colloquy ensued:

THE COURT: Well, to pick up on Mr. Allen’s analogy of the mall, I haven’t been to the Northwest Arkansas mall in a while, but it used to be that there was a restaurant inside the mall that had a bar. And so certainly minors could not go sit at the bar and order up a drink, but they could go to the Barnes & Noble bookstore or the clothing store or the athletic store. Again, borrowing Mr. Allen’s analogy, the gatekeeping that Act 689 imposes is at the front door of the mall, not the bar inside the mall; yes?

THE STATE: The state’s position is that the whole mall is a bar, if you want to continue to use the analogy.

THE COURT: The whole mall is a bar?

THE STATE: Correct.

Clearly, the state’s analogy is not persuasive.

NetChoice argues that Act 689 is not a content-neutral restriction on minors’ ability to access particular spaces online, and the fact that there are so many exemptions to the definitions of “social media company” and “social media platform” proves that the State is targeting certain companies based either on a platform’s content or its viewpoint. Indeed, Act 689’s definitions and exemptions do seem to indicate that the State has selected a few platforms for regulation while ignoring all the rest. The fact that the State fails to acknowledge this causes the Court to suspect that the regulation may not be content neutral. “If there is evidence that an impermissible purpose or justification underpins a facially content-neutral restriction, for instance, that restriction may be content-based.” City of Austin v. Reagan Nat’l Advertising of Austin, LLC, 142 S. Ct. 1464, 1475 (2022).[108]

Utah’s laws HB 311 and 152 would also seem to suffer from a similar defect as KOSA and AADC,[109] though they have not yet been litigated.

B.     Least-Restrictive Means Is to Promote Monitoring and Filtering

Assuming that courts do, in fact, find that these laws are content-based, strict scrutiny would apply, including the least-restrictive-means test.[110] In that case, the caselaw is clear: the least-restrictive means to achieve the government’s interest of protecting minors from social media’s speech and design problems is to promote low-cost monitoring and filtering.

First, however, it is also worth inquiring whether the government would be able to establish a compelling state interest, as the Court discussed in Brown. The Court’s strong skepticism of government paternalism[111] applies equally to the verifiable-parental-consent laws enacted in Arkansas and Utah, as well as COPPA 2.0. Aiding parental consent likely fails to “meet a substantial need of parents who wish to restrict their children’s access”[112] to social media, but can’t do so, to use the late Justice Antonin Scalia’s language. Moreover, the “purported aid to parental authority” is likely to be found to be “vastly overinclusive” because “[n]ot all of the children who are forbidden” to join social media on “their own have parents who care whether” they do so.[113] While such laws “may indeed be in support of what some parents of the restricted children actually want, its entire effect is only in support of what the State thinks parents ought to want. This is not the narrow tailoring to ‘assisting parents’ that restriction of First Amendment rights requires.”[114]

As argued clearly above, Ashcroft is strong precedent that promoting the practical and technological means available in the marketplace, outlined by NetChoice in its brief in Griffin, is less restrictive than age-verification laws to protect minors from harms associated with social-media usage.[115] In fact, there is a strong argument that the market has subsequently produced more and more effective tools than were available even then. This makes it exceedingly unlikely that the Supreme Court will change its mind.

While some have argued that Justice Clarence Thomas’ dissent in Brown offers roadmap to reject these precedents,[116] there is little basis for that conclusion. First, Thomas’ dissent in Brown was not joined by any other members of the Supreme Court.[117] Second, Justice Thomas joined the majority in Ashcroft v. ACLU, suggesting he probably still sees age-verification laws as unconstitutional.[118] Even Associate Justice Samuel Alito issued a concurrence to the majority in that case,[119] expressing skepticism of Justice Thomas’ approach.[120]  Third, it seems unlikely that the newer conservative justices, whose jurisprudence has been more speech-protective by nature,[121] would join Justice Thomas in his opinion on the right of children to receive speech. And far from being vague on the issue of whether a minor has a right to receive speech, [122] Justice Scalia’s majority opinion clearly stated that:

[M]inors are entitled to a significant measure of First Amendment protection, and only in relatively narrow and well-defined circumstances may government bar public dissemination of protected materials to them… but that does not include a free-floating power to restrict the ideas to which children may be exposed.[123]

Precedent is strong against age-verification and parental-consent laws, and there is no reason to think the personnel changes on the Supreme Court would change the analysis.

In sum, straightforward applications of Brown and Ashcroft doom these new social-media laws.

VI.   Conclusion

This issue brief has two main conclusions, one of interest to the scholarship of applying law & economics to constitutional law, and the other to the policy and legal questions surrounding social-media age-verification and parental-consent laws:

1. The Supreme Court appears to implicitly adopt a Coasean framework in its approach to parental-consent and age-verification laws in the three major precedents of Playboy, Ashcroft, and Brown; and
2. The application of this least-cost avoider analysis in the least-restrictive-means test, in particular, is likely to doom these laws constitutionally, but also as a matter of economically grounded policy.

In conclusion, these online age-verification laws should be rejected. Why? The answer is transaction costs.

[1] See, e.g., Kirsten Weir, Social Media Brings Benefits and Risks to Teens. Here’s How Psychology Can Help Identify a Path Forward, 54 Monitor on Psychology 46 (Sep. 1, 2023), https://www.apa.org/monitor/2023/09/protecting-teens-on-social-media.

[2] See, e.g., Khara Boender, Jordan Rodell, & Alex Spyropoulos, The State of Affairs: What Happened in Tech Policy During 2023 State Legislative Sessions?, Project Disco (Jul. 25, 2023), https://www.project-disco.org/competition/the-state-of-affairs-state-tech-policy-in-2023 (noting laws passed and proposed addressing children’s online safety at the state level, including California’s Age-Appropriate Design Code and age-verification laws in both Arkansas and Utah, all of which will be considered below).

[3] With apologies to Mike Munger for borrowing the title of his excellent podcast, invoked several times in this issue brief; see The Answer Is Transaction Costs, https://podcasts.apple.com/us/podcast/the-answer-is-transaction-costs/id1687215430 (last accessed Sept. 28, 2023).

[4] Steven G. Medema, “Failure to Appear”: The Use of the Coase Theorem in Judicial Opinions, at 4, Dep’t of Econ. Duke Univ., Working Paper No. 2.1 (2019), available at https://hope.econ.duke.edu/sites/hope.econ.duke.edu/files/Medema%20workshop%20paper.pdf.

[5] Fred R. Shapiro & Michelle Pearse, The Most Cited Law Review Articles of All Time, 110 Mich. L. Rev. 1483, 1489 (2012).

[6] R.H. Coase, The Problem of Social Cost, 3 J. L. & Econ. 1 (1960).

[7] See generally Steven G. Medema, The Coase Theorem at Sixty, 58 J. Econ. Lit. 1045 (2020).

[8] Todd J. Zywicki & Edward Peter Stringham, Common Law and Economic Efficiency, Geo. Mason Univ.. L. & Econ. Rsch., Working Paper No. 10-43 (2010), available at https://www.law.gmu.edu/assets/files/publications/working_papers/1043CommonLawandEconomicEfficiency.pdf.

[9] See id. at 4.

[10] See id. at 3.

[11] See id. at 10.

[12] See id. at 34.

[13] Medema, supra note 4, at 39.

[14] See, e.g., Matti Cuorre & Andrew K. Przybylski, Estimating the Association Between Facebook Adoption and Well-Being in 72 Countries, 10 Royal Soc’y Open Sci. 1 (2023), https://royalsocietypublishing.org/doi/epdf/10.1098/rsos.221451; Sabrina Cipoletta, Clelia Malighetti, Chiara Cenedese, & Andrea Spoto, How Can Adolescents Benefit from the Use of Social Networks? The iGeneration on Instagram, 17 Int. J. Environ. Res. Pub. Health 6952 (2020), https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7579040.

[15] See Jean M. Twenge, Thomas E. Joiner, Megan L Rogers, & Gabrielle N. Martin, Increases in Depressive Symptoms, Suicide-Related Outcomes, and Suicide Rates Among U.S. Adolescents After 2010 and Links to Increased New Media Screen Time, 6 Clinical Psych. Sci. 3 (2018), available at https://courses.engr.illinois.edu/cs565/sp2018/Live1_Depression&ScreenTime.pdf.

[16] Adam Candeub, Age Verification for Social Media: A Constitutional and Reasonable Regulation, FedSoc Blog (Aug. 7, 2023), https://fedsoc.org/commentary/fedsoc-blog/age-verification-for-social-media-a-constitutional-and-reasonable-regulation.

[17] See Wikipedia, List of Alcohol Laws of the United States, https://en.wikipedia.org/wiki/List_of_alcohol_laws_of_the_United_States (last accessed Sep. 28, 2023); Wikipedia, U.S. History of Tobacco Minimum Purchase Age by State, https://en.wikipedia.org/wiki/U.S._history_of_tobacco_minimum_purchase_age_by_state (last accessed Sep. 28, 2023).

[18] See Wikipedia, Driver’s Licenses in the United States, https://en.wikipedia.org/wiki/Driver%27s_licenses_in_the_United_States (last accessed Sep. 28, 2023).

[19] See Wikipedia, Gambling Age, https://en.wikipedia.org/wiki/Gambling_age (last accessed Sep. 28, 2023) (table on minimum age for lottery tickets and casinos by state). As far as this author is aware, every state and territory requires identification demonstrating the buyer is at least 18 years old to make a retail purchase of a pornographic magazine or video.

[20] See 15 U.S.C. § 6501, et seq. (2018); 16 CFR Part 312.

[21] See infra Part III. See Brown v. Ent. Merch. Ass’n, 564 U.S. 786, 794 (2011) (“California does not argue that it is empowered to prohibit selling offensively violent works to adults—and it is wise not to, since that is but a hair’s breadth from the argument rejected in Stevens. Instead, it wishes to create a wholly new category of content-based regulation that is permissible only for speech directed at children. That is unprecedented and mistaken. ‘[M]inors are entitled to a significant measure of First Amendment protection, and only in relatively narrow and well-defined circumstances may government bar public dissemination of protected materials to them…’ No doubt a State possesses legitimate power to protect children from harm… but that does not include a free-floating power to restrict the ideas to which children may be exposed. ‘Speech that is neither obscene as to youths nor subject to some other legitimate proscription cannot be suppressed solely to protect the young from ideas or images that a legislative body thinks unsuitable for them.’”) (internal citations omitted).

[22] See infra Part V.

[23] See infra Part IV.

[24] 529 U.S. 803 (2000).

[25] Id. at 806.

[26] See id.

[27] See id. at 806-807.

[28] Id. at 811.

[29] Id. at 813 (internal citation omitted).

[30] Id. at 814.

[31] Id. at 815.

[32] Id. at 816.

[33] See id. at 821 (“[M]arket-based solutions such as programmable televisions, VCR’s, and mapping systems []which display a blue screen when tuned to a scrambled signal[] may eliminate signal bleed at the consumer end of the cable.”).

[34] See id. at 823 (“The Government also failed to prove § 504 with adequate notice would be an ineffective alternative to § 505.”).

[35] Id. at 825-826.

[36] 542 U.S. 656 (2004).

[37] Id. at 659.

[38] Id. at 661.

[39] Id. at 662.

[40] Id. at 666.

[41] See id. at 667 (“Filters are less restrictive than COPA. They impose selective restrictions on speech at the receiving end, not universal restrictions at the source. Under a filtering regime, adults without children may gain access to speech they have a right to see without having to identify themselves or provide their credit card information. Even adults with children may obtain access to the same speech on the same terms simply by turning off the filter on their home computers. Above all, promoting the use of filters does not condemn as criminal any category of speech, and so the potential chilling effect is eliminated, or at least much diminished. All of these things are true, moreover, regardless of how broadly or narrowly the definitions in COPA are construed.”).

[42] See id. at 667-669.

[43] See id. at 669-670.

[44] 564 U.S. 786 (2011).

[45] See id. at 787.

[46] Id. at 793-795.

[47] See id. at 794-797.

[48] See id. at 796-799.

[49] See id. at 799-802.

[50] Id. at 801.

[51] Id. at 801-804.

[52] See id. at 812 (J. Alito, concurring):

“There is a critical difference, however, between obscenity laws and laws regulating violence in entertainment. By the time of this Court’s landmark obscenity cases in the 1960’s, obscenity had long been prohibited, See Roth v. U.S., 354 U.S. 476, at 484-485, and this experience had helped to shape certain generally accepted norms concerning expression related to sex.

There is no similar history regarding expression related to violence. As the Court notes, classic literature contains descriptions of great violence, and even children’s stories sometimes depict very violent scenes.

Although our society does not generally regard all depictions of violence as suitable for children or adolescents, the prevalence of violent depictions in children’s literature and entertainment creates numerous opportunities for reasonable people to disagree about which depictions may excite “deviant” or “morbid” impulses. See Edwards & Berman, Regulating Violence on Television, 89 Nw. U.L.Rev. 1487, 1523 (1995) (observing that the Miller test would be difficult to apply to violent expression because “there is nothing even approaching a consensus on low-value violence”).

Finally, the difficulty of ascertaining the community standards incorporated into the California law is compounded by the legislature’s decision to lump all minors together. The California law draws no distinction between young children and adolescents who are nearing the age of majority.”

See also id. at 819 (Alito, J., concurring) (“If the technological characteristics of the sophisticated games that are likely to be available in the near future are combined with the characteristics of the most violent games already marketed, the result will be games that allow troubled teens to experience in an extraordinarily personal and vivid way what it would be like to carry out unspeakable acts of violence.”).

[53] The following sections are adapted from Ben Sperry, Right to Anonymous Speech, Part 3: Anonymous Speech and Age-Verification Laws, Truth on the Market (Sep. 11, 2023), https://truthonthemarket.com/2023/09/11/right-to-anonymous-speech-part-3-anonymous-speech-and-age-verification-laws.

[54] See Ben Sperry, Online Safety Bills Will Mean Kids Are No Longer Seen or Heard Online, The Hill (May 12, 2023), https://thehill.com/opinion/congress-blog/4002535-online-safety-bills-will-mean-kids-are-no-longer-seen-or-heard-online;  Ben Sperry, Bills Aimed at ‘Protecting’ Kids Online Throw the Baby out with the Bathwater, The Hill (Jul. 26, 2023), https://thehill.com/opinion/congress-blog/4121324-bills-aimed-at-protecting-kids-online-throw-the-baby-out-with-the-bathwater; Przybylski & Vuorre, supra note 14; Mesfin A. Bekalu, Rachel F. McCloud, & K. Viswanath, Association of Social Media Use With Social Well-Being, Positive Mental Health, and Self-Rated Health: Disentangling Routine Use From Emotional Connection to Use, 42 Sage J. 69S, 69S-80S (2019), https://journals.sagepub.com/doi/full/10.1177/1090198119863768.

[55] See generally Michael Munger, Tomorrow 3.0: Transaction Costs and the Sharing Economy, Cambridge University Press (Mar. 22, 2018).

[56] The Future of the COPPA Rule: An FTC Workshop Part 2, Federal Trade Commission (Oct. 7, 2019), available at https://www.ftc.gov/system/files/documents/public_events/1535372/transcript_of_coppa_workshop_part_2_1.pdf.

[57] Garrett A. Johnson, Tesary Lin, James C. Cooper, & Liang Zhong, COPPAcalypse? The YouTube Settlement’s Impact on Kids Content, SSRN (Apr. 26, 2023), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4430334.

[58] Id. at 6-7 (emphasis added).

[59] Id. at 1.

[60] FTC, supra note 56.

[61] Id. at 6 (emphasis added).

[62] See Michael Munger, To Consumers, All Costs are Transaction Costs, Am. Inst. Econ. Rsch. (June 13, 2023), https://www.aier.org/article/to-consumers-all-costs-are-transaction-costs.

[63] See Katie Robertson, Meta Begins Blocking News in Canada, N.Y. Times (Aug. 2, 2023), https://www.nytimes.com/2023/08/02/business/media/meta-news-in-canada.html; Mark Collom, Australia Made a Deal to Keep News on Facebook. Why Couldn’t Canada?, CBC News (Aug. 3, 2023), https://www.cbc.ca/news/world/meta-australia-google-news-canada-1.6925726.

[64] See id.

[65] Free Speech Coal. Inc. v. Colmenero, No. 1:23-CV-917-DAE, 2023 U.S. Dist. LEXIS 154065 (W.D. Tex. 2023), available at https://storage.courtlistener.com/recap/gov.uscourts.txwd.1172751222/gov.uscourts.txwd.1172751222.36.0.pdf.

[66] Id. at 10.

[67] Id.

[68] Id.

[69] Id. at 44.

[70] Geoffrey A. Manne, Ben Sperry, & Kristian Stout, Who Moderates the Moderators?: A Law & Economics Approach to Holding Online Platforms Accountable Without Destroying the Internet, 49 Rutgers Comput. & Tech. L.J. 26 (2022), https://laweconcenter.org/resources/who-moderates-the-moderators-a-law-economics-approach-to-holding-online-platforms-accountable-without-destroying-the-internet; Geoffrey A. Manne, Kristian Stout, & Ben Sperry, Twitter v. Taamneh and the Law & Economics of Intermediary Liability, Truth on the Market (Mar. 8, 2023), https://truthonthemarket.com/2023/03/08/twitter-v-taamneh-and-the-law-economics-of-intermediary-liability; Ben Sperry, The Law & Economics of Children’s Online Safety: The First Amendment and Online Intermediary Liability, Truth on the Market (May 12 2023), https://truthonthemarket.com/2023/05/12/the-law-economics-of-childrens-online-safety-the-first-amendment-and-online-intermediary-liability.

[71] See Manne, Stout, & Sperry, Twitter v. Taamneh and the Law & Economics of Intermediary Liability, supra note 70; Ben Sperry, Right to Anonymous Speech, Part 2: A Law & Economics Approach, Truth on the Market. (Sep. 6, 2023), httsps://truthonthemarket.com/2023/09/06/right-to-anonymous-speech-part-2-a-law-economics-approach; Manne, Sperry, & Stout, Who Moderates the Moderators?: A Law & Economics Approach to Holding Online Platforms Accountable Without Destroying the Internet, supra note 70.

[72] See Manne, Stout, & Sperry, Who Moderates the Moderators?: A Law & Economics Approach to Holding Online Platforms Accountable Without Destroying the Internet, supra note 70, at 28 (“To the extent that the current legal regime permits social harms online that exceed concomitant benefits, it should be reformed to deter those harms, provided it can be done so at sufficiently low cost.”); Sperry, Right to Anonymous Speech, Part 2: A Law & Economics Approach, supra note 71.

[73] See NetChoice Complaint, NetChoice LLC v. Griffin, NO. 5:23-CV-05105, available at 2023 U.S. Dist. LEXIS 154571 (W.D. Ark. 2023), https://netchoice.org/wp-content/uploads/2023/06/NetChoice-v-Griffin_-Complaint_2023-06-29.pdf.

[74] Id. at para. 13.

[75] See id. at para. 14

[76] See id.

[77] See id. at para 15.

[78] See id. at para 16.

[79] See id.

[80] See id. at para. 17, 19-21

[81] See Ben Sperry, Congress Should Focus on Protecting Teens from Real Harms, Not Targeted Ads, The Hill (Feb. 12, 2023), https://thehill.com/opinion/congress-blog/3862238-congress-should-focus-on-protecting-teens-from-real-harms-not-targeted-ads.

[82] See NetChoice Complaint, supra note 73 at para. 18.

[83] Government Response to the Roadmap for Age Verification, Australian Gov’t Dep’t of Infrastructure, Transp., Reg’l Dev., Commc’ns and the Arts (Aug. 2023), available at https://www.infrastructure.gov.au/sites/default/files/documents/government-response-to-the-roadmap-for-age-verification-august2023.pdf.

[84] See Josh Taylor, Australia Will Not Force Adult Websites to Bring in Age Verification Due To Privacy And Security Concerns, The Guardian (Aug. 30, 2023), https://www.theguardian.com/australia-news/2023/aug/31/roadmap-for-age-verification-online-pornographic-material-adult-websites-australia-law.

[85] See NetChoice Complaint, supra note 73 at 2.

[86] Id. at 6.

[87] See id.

[88] See id. at 6-8.

[89] Supra Part IV.A.

[90] See Children and Teen’s Online Privacy Protection Act, S. 1418, 118^th Cong. (2023), as amended Jul. 27, 2023, available at https://www.congress.gov/bill/118th-congress/senate-bill/1418/text (last accessed Oct. 2, 2023). Other similar bills have been proposed as well. See Protecting Kids on Social Media Act, S. 1291, 118th Cong. (2023); Making Age-Verification Technology Uniform, Robust, and Effective Act, S. 419, 118th Cong. (2023); Social Media Child Protection Act, H.R. 821, 118th Cong. (2023).

[91] See David Neumark & Peter Shirley, Myth or Measurement: What Does the New Minimum Wage Research Say About Minimum Wages and Job Loss in the United States? (Nat’l Bur. Econ. Res. Working Paper 28388, Mar. 2022), available at https://www.nber.org/papers/w28388 (concluding that “(i) there is a clear preponderance of negative estimates in the literature; (ii) this evidence is stronger for teens and young adults as well as the less-educated; (iii) the evidence from studies of directly-affected workers points even more strongly to negative employment effects; and (iv) the evidence from studies of low-wage industries is less one-sided.”).

[92] See Lisa Sturtevant, The Impacts of Rent Control: A Research Review and Synthesis, at 6-7, Nat’l Multifamily Hous. Coun’cl Res. Found. (May 2018), available at https://www.nmhc.org/globalassets/knowledge-library/rent-control-literature-review-final2.pdf (“1. Rent control and rent stabilization policies do a poor job at targeting benefits. While some low-income families do benefit from rent control, so, too, do higher-income households. There are more efficient and effective ways to provide assistance to lower-income individuals and families who have trouble finding housing they can afford. 2. Residents of rent-controlled units move less often than do residents of uncontrolled housing units, which can mean that rent control causes renters to continue to live in units that are too small, too large or not in the right locations to best meet their housing needs. 3. Rent-controlled buildings potentially can suffer from deterioration or lack of investment, but the risk is minimized when there are effective local requirements and/or incentives for building maintenance and improvements. 4. Rent control and rent stabilization laws lead to a reduction in the available supply of rental housing in a community, particularly through the conversion to ownership of controlled buildings. 5. Rent control policies can hold rents of controlled units at lower levels but not under all circumstances. 6. Rent control policies generally lead to higher rents in the uncontrolled market, with rents sometimes substantially higher than would be expected without rent control. 7. There are significant fiscal costs associated with implementing a rent control program.”).

[93] See Candeub, supra note 16.

[94] Colmenero, supra note 65, at 22.

[95] See Kids Online Safety Act, S. 1409, 118th Cong. (2023), as amended and posted by the Senate Committee on Commerce, Science , and Transportation on July 27, 2023, available at https://www.congress.gov/bill/118th-congress/senate-bill/1409/text#toc-id6fefcf1d-a1ae-4949-a826-23c1e1b1ef26 (last accessed Oct. 2, 2023).

[96] See id. at Section 3.

[97] Cf. Manhattan Community Access Corp. v. Halleck, 139 S. Ct. 1921, 1930-31 (2019):

[M]erely hosting speech by others is not a traditional, exclusive public function and does not alone transform private entities into state actors subject to First Amendment constraints…

If the rule were otherwise, all private property owners and private lessees who open their property for speech would be subject to First Amendment constraints and would lose the ability to exercise what they deem to be appropriate editorial discretion within that open forum. Private property owners and private lessees would face the unappetizing choice of allowing all comers or closing the platform altogether.

[98] See Counterman v. Colorado, 600 U.S. 66 (2023); Ben Sperry (@RBenSperry), Twitter (June 28, 2023, 4:46 PM), https://twitter.com/RBenSperry/status/1674157227387547648.

[99] Cf. HØEG v. Newsom, 2023 WL 414258 (E.D. Cal. Jan. 25, 2023); Sperry, The Law & Economics of Children’s Online Safety: The First Amendment and Online Intermediary Liability, supra note 70.

[100] California Age-Appropriate Design Code Act, AB 2273 (2022), https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=202120220AB2273.

[101] See id. at § 1798.99.32(d)(1), (2), (4).

[102] See Candeub, supra note 16.

[103] NetChoice LLC. v. Griffin, Case No. 5:23-CV-05105 at 25 (Aug. 31, 2023), slip op., available at https://netchoice.org/wp-content/uploads/2023/08/GRIFFIN-NETCHOICE-GRANTED.pdf.

[104] Id.

[105] Id. at 38 (“Having considered both sides’ positions on the level of constitutional scrutiny to be applied, the Court tends to agree with NetChoice that the restrictions in Act 689 are subject to strict scrutiny. However, the Court will not reach that conclusion definitively at this early stage in the proceedings and instead will apply intermediate scrutiny, as the State suggests.”).

[106] Id. at 48 (“In sum, NetChoice is likely to succeed on the merits of the First Amendment claim it raises on behalf of Arkansas users of member platforms. The State’s solution to the very real problems associated with minors’ time spent online and access to harmful content on social media is not narrowly tailored. Act 689 is likely to unduly burden adult and minor access to constitutionally protected speech. If the legislature’s goal in passing Act 689 was to protect minors from materials or interactions that could harm them online, there is no compelling evidence that the Act will be effective in achieving those goals.”).

[107] See NetChoice v. Bonta, Case No. 22-cv-08861-BLF (N.D. Cal. Sept. 18, 2023), slip op., available at https://netchoice.org/wp-content/uploads/2023/09/NETCHOICE-v-BONTA-PRELIMINARY-INJUNCTION-GRANTED.pdf; Ben Sperry, What Does NetChoice v. Bonta Mean for KOSA and Other Attempts to Protect Children Online?, Truth on the Market (Sep. 29, 2023), https://truthonthemarket.com/2023/09/29/what-does-netchoice-v-bonta-mean-for-kosa-and-other-attempts-to-protect-children-online.

[108] Id. at 36-38.

[109] See Carl Szabo, NetChoice Sends Veto Request to Utah Gov. Spencer Cox on HB 311 and SB 152, NetChoice (Mar. 3, 2023),  https://netchoice.org/netchoice-sends-veto-request-to-utah-gov-spencer-cox-on-hb-311-and-sb-153.

[110] See, e.g., Sable Commcn’s v. FCC, 492 U.S. 115, 126 (1989) (“The Government may, however, regulate the content of constitutionally protected speech in order to promote a compelling interest if it chooses the least restrictive means to further the articulated interest.”).

[111] Brown, 564 U.S. at 801 (“California claims that the Act is justified in aid of parental authority: By requiring that the purchase of violent video games can be made only by adults, the Act ensures that parents can decide what games are appropriate. At the outset, we note our doubts that punishing third parties for conveying protected speech to children just in case their parents disapprove of that speech is a proper governmental means of aiding parental authority.”).

[112] Brown, 564 U.S. at 801.

[113] Id. at 803

[114] Id.

[115] See supra IV.B.

[116] See Clare Morrell, Adam Candeub, & Michael Toscano, No, Big Tech Doesn’t Have A Right To Speak To Kids Without Their Parent’s Consent, The Federalist (Sept. 21, 2023), https://thefederalist.com/2023/09/21/no-big-tech-doesnt-have-a-right-to-speak-to-kids-without-their-parents-consent (noting “Justice Clarence Thomas wrote in his dissent in the Brown case that “the ‘freedom of speech,’ as originally understood, does not include a right to speak to minors (or a right of minors to access speech) without going through the minors’ parents or guardians.”).

[117] Brown, 564 U.S. at 821.

[118] Id. at 822.

[119] Id. at 805.

[120] Id. at 813.

[121] See, e.g., Ben Sperry, There’s Nothing ‘Conservative’ About Trump’s Views on Free Speech and the Regulation of Social Media, Truth on the Market (Jul. 12, 2019), https://truthonthemarket.com/2019/07/12/theres-nothing-conservative-about-trumps-views-on-free-speech (noting Kavanaugh’s majority opinion in Halleck on compelled speech included all the conservative justices; at the time he and Gorsuch were relatively new Trump appointees); Justice Amy Comey Barrett has also joined the majority opinion in 303 Creative LLC v. Elenis, 600 U.S. 570 (2023), written by Gorsuch and joined by all the conservatives, which found public-accommodations laws are subject to strict scrutiny if they implicate expressive activity.

[122] Clare Morell (@ClareMorellEPPC), Twitter (Sept. 7, 2023, 8:27 PM), https://twitter.com/ClareMorellEPPC/status/1699942446711357731.

[123] Brown, 564 U.S. at 786.

When my family and I moved to rural America from Armenia in the mid-1990s, we found that it stood true to its reputation as the land of opportunity and abundance. Work was readily available, and my parents also found opportunities to pursue other sources of income through self-employment, contracting and starting their own businesses.

Read the full piece here.

Way back in May, I cracked wise about the Federal Trade Commission’s (FTC) fictional “Bureau of Let’s Sue Meta,” noting that the commission’s proposal (really, an “order to show cause”) to modify its 2020 settlement of a consumer-protection matter with what had then been Facebook—in other words, a settlement modifying a 2012 settlement—was the FTC’s third enforcement action with Meta in the first half of 2023. That seemed like a lot, even if we ignored, say, Meta’s European and UK matters (see, e.g., here on the EU Digital Markets Act’s “gatekeeper” designations; here on the Norwegian data-protection authority; here and here on the Court of Justice of the European Union, and here on the UK Competition Appeal Tribunal).

Read the full piece here.

tl;dr

Background: In the U.S. Justice Department’s (DOJ) recent suit against Google and the Federal Trade Commission’s (FTC) latest complaint against Amazon, both antitrust agencies allege these large technology firms behave anti-competitively by preventing their rivals from reaching the “scale” needed to compete effectively.

But… achieving scale or a large customer base does not, in itself, violate antitrust law. Private companies also owe no duty to allow their competitors to reach scale. For example, Google is not required to allow Bing to gain more users so that Bing’s quality can improve. Google and Amazon’s competition for users at the expense of competitors is central to the competitive process. To make an effective antitrust case, the agencies must delineate how Amazon and Google allegedly abuse their size in ways that harm competition and consumers.

KEY TAKEAWAYS

‘SCALE’ LACKS PRECISION IN ANTITRUST

Antitrust regulators often cite “scale” in recent complaints against large tech companies. Instead of throwing that particular term around loosely, the enforcement agencies should detail precisely how firms allegedly abuse scale to harm rivals. 

Does scale unfairly raise barriers to entry? Does it impose costs on competitors? In both of the cases cited above, the alleged harm is the direct costs imposed on competitors, not the firm’s scale. After all, scale can be just another way of describing the firm that produces the highest-quality product at the lowest price. Without greater clarity, enforcement agencies would be unable to substantiate antitrust claims centered on “scale.”

To prevail in court, the agencies must articulate precise mechanisms of competitive injury from scale. Broad assertions about nebulous “scale advantages” are unlikely to demonstrate concrete anticompetitive effects. 

SCALE ALONE IS NOT AN ANTITRUST HARM

It has long been recognized that simply “achieving scale” and becoming a large firm with significant market share or production capacity does not constitute an antitrust violation. No law prohibits a company from growing large through legal competitive means. The agencies know this. The FTC argues that its complaint against Amazon is “not for being big.”

While scale can potentially be abused, it also confers significant consumer advantages. Basic economic principles demonstrate the benefits of size or scale, which may allow larger firms to reduce average costs and become more efficient. These cost savings can then be passed on to consumers through lower prices. Larger firms may also be able to make more substantial investments in innovation and product development. And network effects in technology platforms show how scale can improve service quality by attracting more users. 

Scale only becomes an issue if it is leveraged to restrain trade unfairly or in ways that harm consumers. The restraint is the harm, not the scale.

PREVENTING SCALE IS NOT AN ANTITRUST HARM 

Preventing a competitor from achieving greater size and scale is not inherently an antitrust violation either. Companies routinely take business from one another through price competition, product improvements, or other means that may limit rivals’ growth. This is a normal part of market competition. 

For example, if Amazon achieves sufficient scale that allows it to offer better prices or selection than smaller e-commerce websites, that may necessarily limit those competitors’ scale. But this does not constitute an antitrust harm; it is, instead, simply vigorous competition. An antitrust violation requires the firm to take specific actions to restrain trade or artificially raise rivals’ costs. Similar arguments hold for the DOJ’s case against Google over the company paying to be the default search engine on various mobile devices. 

Unless the agencies can demonstrate precisely how a company has abused its position to undermine rivals’ scale unfairly—rather than winning business through competition on the merits—their complaints will struggle to establish antitrust liability.

COMPETITION INCREASES CONCENTRATION, WHICH MAY LOOK LIKE SCALE

Regulators often assume that large scale enables anticompetitive behavior to harm smaller rivals. Economic analysis, however, demonstrates that scale can benefit consumers and simultaneously increase concentration through competition.

Firms that achieve significant scale can leverage resulting efficiencies to reduce costs and prices. Scale enables investments in R&D, specialized assets, advertising, and other drivers of innovation and productive efficiency. By passing cost savings on to consumers, scaled firms often gain share at the expense of higher-cost producers.

As search and switching costs fall, consumers flock to the lowest-cost and highest-quality offerings. Competition redirects purchases toward scaled companies with superior productivity and lower prices stemming from economies of scale. This reallocates market share to efficient large firms, raising concentration.

Greater competition and the competitive advantages of scale are thus entirely consistent with increased concentration. Size alone does not imply anticompetitive behavior. Regulators should evaluate specific evidence of abuse, rather than assume that scale harms competition simply because it leads to concentration.

For more on this issue, see Brian Albrecht’s posts “Is Amazon’s Scale a Harm?” and “Competition Increases Concentration,” both at Truth on the Market. 

Meta gave European users of Facebook and Instagram a choice between paying for a no-ads experience or keeping the services free of charge and with ads. As I discussed previously (Facebook, Instagram, “pay or consent” and necessity to fund a service and EDPB: Meta violates GDPR by personalised advertising. A “ban” or not a “ban”?), the legal reality behind that choice is more complex. Users who continue without paying are asked to consent for their data to be processed for personalized advertising. In other words, this is a “pay or consent” framework for processing first-party data.

I was asked by IAPP, “the largest privacy association in the world and a leader in the privacy industry,” to discuss this. I also thought that the text I wrote for them could use some additional explanations for this substack’s audience. What follows is an expanded version of the text published by IAPP. (If this text is too long, I suggest reading just the next section).

Read the full piece here.

This is the second post about the U.S. drug-approval process; the first post is here. It will explore how the Food and Drug Administration (FDA) arose, how disasters drove its expansion and regulatory oversight, and how the epidemic of the human immunodeficiency virus (HIV) changed the approval processes.

Read the full piece here.

Hootenannies are mostly peaceful affairs, so it’s a bit awkward to invoke a violent metaphor here.

In “Raiders of the Lost Ark,” Indiana Jones runs down a Cairo sidestreet only to be confronted by a swordsman. The swordsman makes a big show of tossing his weapon from hand-to-hand and swirling it around. But Indy has no time for such nonsense—he pulls out his gun and shoots the would-be assassin.

U.S. spectrum policy is much like the swordsman. While the telecom regulators swirl around studies of how to allocate spectrum, the rest of the world is pulling the trigger.

Read the full piece here.

In a widely discussed move, Meta gave Facebook and Instagram users the choice between paying for an ad-free experience or keeping the services free of charge using ads. The legal reality behind that choice is more complex. Users who continue without paying are asked to consent to the processing of their data for personalized advertising. In other words, this is a “pay or consent” framework for the processing of first-party data. 

Read the full piece here.

This is the first in what will be a series of posts discussing how new medicines are introduced and regulated in the United States, and how the status quo could be improved. As will be established over the course of the series, the current system is slow and leads to poor outcomes for patients.

Read the full piece here.

Reading comments (Ben Thompson, Eric Seufert) on the Meta-Amazon deal to let “shoppers buy Amazon products directly from ads on Instagram and Facebook” (Bloomberg) made me think: could it happen here (in the EU)? Would EU law block it? I don’t think so. Still, given that the deal means “more data for Meta” (and Amazon), we’ll likely see some knee-jerk critical reactions. So, I thought it would be interesting to think through this question. (To be clear: this is not a full legal analysis, just my quick thoughts).

Read the full piece here.

The U.S. Justice Department’s landmark antitrust case against Google has wrapped up, leaving the parties to await Judge Amit Mehta’s bench-trial decision in the matter.

But based on the arguments presented and the publicly available evidence, the government has not made its case that the company committed “monopoly maintenance.”

Read the full piece here.

Ayear ago, we cautioned that the EU Cybersecurity Certification Scheme for Cloud Services (EUCS) threatened to embed ill-conceived economic protectionism into the EU’s cybersecurity rules. And, indeed, the European Commission, which has made clear its commitment to pursue “digital sovereignty” for the European Union, can claim some preliminary successes on that front.

A recent draft of EUCS shows that the European Union Agency for Cybersecurity (ENISA) heeded the Commission’s call, contrary to ENISA’s own prior recommendations. Most notably, the draft would preclude entities outside the EU and those under foreign ownership or control from receiving  the highest level of cybersecurity certification.

Read the full piece here.

It happens at just about every hootenanny. There’s always at least one song that clears the dance floor. Some tunes, people just won’t dance to. But with a little remixing and a better tempo, even a dirge can be danceable.

For years, the Federal Communications Commission (FCC) has refused to dance to the tune of research that suggests Title II regulation depresses broadband investment. But a recently published paper changes the tune so much that the FCC can’t—or at least shouldn’t—ignore the vibe.

Read the full piece here.

Amazon against the DSA ad database duty: The new Digital Services Act (DSA) includes a duty for very large online platforms (VLOPs) to “compile and make publicly available an advertisement repository.” Amazon challenged this duty before the EU’s General Court, which made a preliminary decision to temporarily suspend the application of that duty to Amazon.

Read the full piece here.

The European Commission late last month published the full list of its “gatekeeper” designations under the Digital Markets Act (DMA). Alphabet, Amazon, Apple, ByteDance, Meta, and Microsoft—the six designated gatekeepers—now have six months to comply with the DMA’s list of obligations and restrictions with respect to their core platform services (CPS), or they stand to face hefty fines and onerous remedies (see here and here for our initial reactions).

Read the full piece here.

In order to promote competition in digital markets,^[1] Latin American countries should not copy and paste “solutions” from other jurisdictions, but rather design their own set of policies. In short, Latin American countries—like my own, Peru—should not “put the cart before the horse” and regulate markets that are not yet mature.

Read the full piece here.

Idon’t mean to sound like a broken record, but why is the Federal Communications Commission (FCC) playing a broken record?

I’ve been writing a fair bit about Federal Trade Commission (FTC) rulemaking initiatives. On the theory that you deserve a nominal break from all of that, this post is mostly about the FCC.

On Sept. 28, the FCC published a “fact sheet” and a notice of proposed rulemaking (NPRM) on “Safeguarding and Securing the Open Internet.” Just shy of a month later, on Oct. 25, the FCC published another “fact sheet” and NPRM—this one, on “Preventing Digital Discrimination.”

My International Center for Law & Economics (ICLE) colleague Eric Fruits has written about the proposals here, here, here, here, here, and, with our colleague Ben Sperry, here. ICLE’s Kristian Stout is here. Eric explains how, in relatively straightforward fashion, the anti-discrimination requirements could lead to price regulation, notwithstanding the FCC’s own observation that “there is little to no evidence of intentional digital discrimination of access.”

Read the full piece here.

The Biden administration’s Oct. 30 “Executive Order on the Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence” proposes to “govern… the development and use of AI safely and responsibly” by “advancing a coordinated, Federal Government-wide approach to doing so.” (Emphasis added.)

This “all-of-government approach,” which echoes the all-of-government approach of the 2021 “Executive Order on Competition” (see here and here), establishes a blueprint for heightened regulation to deal with theorized problems stemming from the growing use of AI by economic actors. As was the case with the competition order, the AI order threatens to impose excessive regulatory costs that would harm the American economy and undermine competitive forces. As such, the order’s implementation warrants close scrutiny.

Read the full piece here.

Federal Communications Commission (FCC) Chair Jessica Rosenworcel this week announced a notice of inquiry (NOI) seeking input on a proposal to raise the minimum connection-speed benchmarks that the commission uses to define “broadband.” The current benchmark speed is 25/3 Mbps. The chair’s proposal would raise the benchmark to 100/20 Mbps, with a goal of having a benchmark of 1000/500 Mbps by the year 2030.

Read the full piece here.

It is no coincidence that ordoliberalism—the European (originally German) alternative to classical liberalism that emphasized the importance of the “social market” economy—and the New Brandeis or “neo-Brandeisian” movement, which harkens back to the Progressive Era thought of the late U.S. Supreme Court Justice Louis Brandeis, both are enjoying comebacks simultaneously. The effects of these ideological resurgences are most apparent specifically in the field of antitrust law (see here and here). But you can also see them in the broader political-economy movement to formulate an alternative to “neoliberalism” (here and here) that at least some audience find appealing.

The antitrust mainstream has long dismissed the ideas associated with these movements as populist, romantic, or naïve. Being called an “ordoliberal” was, until relatively recently, considered an epithet in Europe. And before individuals associated with their views were elevated into the U.S. antitrust establishment, gaining the attendant aura of respectability that accompanies occupying such lofty heights, the neo-Brandeisians were commonly derided as practicing “hipster antitrust.”

But these glib dismissals underestimated, at their own expense, the visceral appeal of the arguments the ordoliberals and neo-Brandeisians put forward. Ideas that had been relegated to the fringes of academia have begun to seep into the mainstream, and now threaten to upend the “neoliberal” antitrust order—all because opponents refused to take them seriously. As in the past, this trend can only be reverted through a better understanding of why these ideologies are so attractive, and why they ultimately fall flat.

Read the full piece here.

Here in New Jersey, where I live, the day before Halloween is commonly celebrated as “Mischief Night,” an evening of adolescent revelry and light vandalism that typically includes hurling copious quantities of eggs and toilet paper.

It is perhaps fitting, therefore, that President Joe Biden chose Oct. 30 to sign a sweeping executive order (EO) that could itself do quite a bit of mischief. And befitting the Halloween season, in proposing this broad oversight regime, the administration appears to be positively spooked by the development of artificial intelligence (AI).

The order, of course, embodies the emerging and now pervasive sense among policymakers that they should “do something” about AI; the EO goes so far as to declare that the administration feels “compelled” to act on AI. It largely directs various agencies to each determine how they should be involved in regulating AI, but some provisions go further than that. In particular, directives that set new reporting requirements—while ostensibly intended to forward the reasonable goal of transparency—could end up doing more harm than good.

Read the full piece here.

RE: Amicus Letter Supporting Review in Liapes v. Facebook, Inc. (No. S282529), From a Decision by the Court of Appeal, First Appellate District, Division 3 (No. A164880)

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 and has longstanding expertise evaluating antitrust law and policy. We thank the Court for considering this amicus letter supporting Petitioner Facebook’s petition for review in which we wish to briefly highlight some of the crucial considerations that we believe should be taken into account when looking at the intermediary liability principles that underlie the interpretation of the Unruh Act.

The Court of Appeal’s decision in Liapes v. Facebook has profound implications for online advertising and raises significant legal and practical concerns that could echo beyond the advertising industry. Targeted advertising is a crucial aspect of marketing, enabling advertisers to direct benign, pro-consumer messages to potential customers based on various considerations, including age and gender. The plaintiff’s argument, and the Court of Appeal’s acceptance of it, present a boundless theory of liability, suggesting that any targeted advertising based on protected characteristics is unlawful. This theory of liability, unfortunately, fails to take account of the nature of Facebook as an online intermediary, and the optimal limitations on liability that this requires when weighing the bad acts of third parties against Facebook’s attempt to provide neutral advertising tools to the benefit of millions of users.

The Unruh Act Is Not a Strict Liability Statute

While the Unruh Act prohibits intentional discrimination, California Civil Code §§ 51 and 51.5, California courts have consistently emphasized that the statute does not impose strict liability for all differential treatment. Rather, the Unruh Act allows for distinctions that serve legitimate nondiscriminatory purposes.

Courts have held that the Unruh Act does not bar practices “justified by ‘legitimate business interests.'” Koebke v. Bernardo Heights Country Club, 36 Cal. 4th 824, 851 (2005). The statute prohibits only discrimination that is “arbitrary, invidious or unreasonable.” Javorsky v. Western Athletic Clubs, Inc., 242 Cal. App. 4th 1386, 1395 (2015). Reasonable, nonarbitrary distinctions are therefore permissible. Differential treatment may qualify as reasonable and nonarbitrary if there is a public policy justification for the distinction. For example, discounts for senior citizens have been deemed nonarbitrary because they advance policies like assisting those with limited incomes. Sargoy v. Resolution Trust Corp., 8 Cal. App. 4th 1039, 1044 (1992). And it is “reasonable” discrimination on the basis of age to prevent minors from entering bars and adult bookstores. Koire v. Metro Car Wash, 40 Cal. 3d 24, 31 (1985).

Thus, the Unruh Act does not impose strict liability merely for practices that have a disparate impact. Harris v. Capital Growth Investors XIV, 52 Cal. 3d 1142, 1149 (1991). While the Unruh Act provides robust protections, it was not intended to forbid all differential treatment. Distinctions based on legitimate justifications remain permissible under the statute’s exceptions.

Firms like Meta operate services facilitating billions of interactions between users and advertisers. In this vast, complex environment, interpreting any ad targeting based on protected class membership as a per se Unruh Act violation would amount to imposing de facto strict liability on the online advertising industry. Setting aside the fact that the Unruh Act is not a strict liability statute, drawing the liability line at this point would have drastic practical consequences.

First, a de facto strict liability standard fails to account for the immense scale and complexity of services like Facebook. Given the number of third-party advertisers and users, as well as the speed and quantity of ad auctions, some incidental correlations between ad delivery and protected characteristics are likely inevitable even absent purposeful exclusions. The Court of Appeal’s opinion exposes both advertisers and platforms like Facebook to litigation based on such correlations, on the theory that the correlations may be “probative” of the intentional discrimination the Unruh Act forbids.

Second, advertisers may have many reasonable, nonarbitrary motivations for targeting their ads to certain demographic groups. For example, targeting older people for certain kinds of medicines, or members of religious groups with information about services in their religion. The Court of Appeal’s opinion will lead to extensive, costly litigation about potential justification for such ad targeting, and in the meantime consumers will be deprived of useful ads.

Finally, if any segmentation of ad targets based on protected characteristics triggers Unruh Act violations, online advertising loses an essential tool for connecting people with relevant messages. This impedes commerce without any showing of invidious discrimination.

Although the Unruh Act provides important protections, overbroad interpretations amount to strict liability incompatible with the realities of a massive, complex ad system. Nuance is required to balance anti-discrimination aims with the actual welfare of users of services. In order to properly parse the line between reasonable and unreasonable discrimination when dealing with a neutral advertising service like Facebook and the alleged bad acts of third parties, it is necessary to incorporate the legal principles of intermediary liability into an analysis under the Unruh Act.

Principles of Intermediary Liability

In public policy and legal analysis, a central objective is to align individual incentives with social welfare, thereby deterring harmful behavior and encouraging optimal levels of precaution. See Guido Calabresi, The Cost of Accidents: A Legal and Economic Analysis 26 (1970). In the online context, this principle necessitates a careful examination of intermediary liability, especially for actors indirectly involved in online interactions.

Intermediary liability applies to third parties not directly causing harm but who can influence primary actors’ behavior to reduce harm cost-effectively. This is particularly relevant when direct deterrence is insufficient, and the intermediary can prevent harm more effectively or at a lower cost than direct enforcement. See Reiner Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 56-57 (1986). However, not every intermediary in a potentially harmful transaction should be a target for such liability.

The focus is on locating the “least-cost avoider” – the party that can reduce the likelihood of harm at the lowest overall cost. See Harold Demsetz, When Does the Rule of Liability Matter?, 1 J. of Leg. Stud. 13, 28 (1972); see also Kraakman, supra, at 61 (“[t]he general problem remains one of selecting the mix of direct and collateral enforcement measures that minimizes the total costs of misconduct and enforcement”). This approach aims to balance the costs of enforcement against the social gains achieved as well as the losses that flow from the chilling effects of liability.

Imposing liability involves weighing the administrative costs and the potential lost benefits society might enjoy in the absence of liability. See Ronald Coase, The Problem of Social Cost, 3 J.L. & Econ. 1, 27 (1960) (“[W]hat has to be decided is whether the gain from preventing the harm is greater than the loss which would be suffered elsewhere as a result of stopping the action which produces the harm.”). The least-cost avoider is determined by considering whether the reduction in costs from locating liability on that party is outweighed by the losses caused by restricting other activities that flow from that liability. Calabresi, supra at 141.

The internet comprises various intermediaries like interactive computer services, internet service providers, content delivery networks, and advertising networks, which facilitate interactions between users, content platforms, and various service providers. See generally David S. Evans, Platform Economics: Essays on Multi-Sided Businesses (2011). Sometimes, intermediaries are the least-cost avoiders, especially when information costs are low enough for them to monitor and control end users effectively, or when it is difficult or impossible to identify bad actors using those platforms. But this is not always the case.

While liability can induce actors to take efficient precautions, intermediaries often cannot implement narrow precautions due to limited information or control. Facebook’s platform illustrates this challenge: Facebook has limited to no access to information about the motivations or design of every one of the millions of ad campaigns from millions of individual advertisers on its platform at any given time. Thus, avoiding liability risk might entail broad actions like reducing all services, including those supporting beneficial activities. If the collateral costs in lost activity are significant, the benefits of imposing intermediary liability may not justify its implementation.

Here, overbroad liability could end up severely reducing the effectiveness of advertising in general. This could result in 1) less relevant advertisements for users of online services; 2) reduced value to advertising for businesses, harming in particular small businesses which have limited advertising budgets, and 3) less revenue for online services which rely on advertising revenue, pressuring them to increase revenue through other means like higher ad prices and subscriptions.

The individuals and businesses placing advertisements, not the intermediary ad platform, are the primary actors choosing whether and how to use tools for targeting. As we noted above, under the Unruh Act there are permissible uses of targeted advertising, even when focusing on protected classes. The focus in discouraging discrimination should be on primary actors.

It is not hard to locate parties misusing Facebook’s advertising tools in a way that potentially violates the Unruh Act when evidence of discrimination is presented. On the other hand, intermediaries like Facebook will often lack particularized ex ante knowledge of specific discriminatory transactions or direct control over advertisers’ targeting choices. The only avenue for Facebook to comply with broad liability under the Unruh Act is to altogether remove the ability of businesses to use any characteristic that might theoretically trigger Unruh Act liability, which would result in the harms described above. In situations like this, where the intermediary has little ability to effectively police certain misuses of otherwise benign, neutral tools that enhance social welfare, the case for imposing collateral liability is weakened.

Moreover, some statistically disproportionate ad delivery outcomes may be inevitable given the vast scale of platforms like Facebook. Disparate effects should not automatically equate to impermissible discrimination absent purposeful exclusion. The creation of neutral tools for use by advertisers who then use them to break the law does not imply intentionality by Facebook (or any other advertising platform) to break the law. No one would suggest that a hammer company intends for its product to be misused by customers who use it to bludgeon another human being. Nuance is required.

Broad Unruh Act liability risks unintended harms. Imposing a de facto strict liability regime that treats all ad targeting of protected classes as impermissible under the Unruh Act would drive services like Facebook to restrict lawful advertising tools for all users in order to mitigate liability risks. This impairs a large amount of indisputably legal commerce to deter allegedly illegal advertising by a subset of third parties. Moreover, the effects of such a decision would echo not only throughout the advertising ecosystem, but throughout the internet ecosystem in general where intermediaries might provide similar neutral tools that could run afoul of such a broad theory of liability.

Conclusion

The intermediary liability principles outlined above strongly counsel against the overbroad Unruh Act interpretation embraced by the Court of Appeal in the present matter.

The primary actors are the advertisers choosing whether and how to target ads, not Facebook. The Court of Appeal’s broad view wrongly focused on Facebook’s provision of neutral tools rather than advertisers’ specific uses of those tools.

Given the context-dependent nature of an Unruh Act analysis, the Court of Appeal failed to appropriately balance between deterring allegedly illegal acts by advertisers with the potential loss of value from targeted advertising altogether. The proper duties of intermediaries like Facebook should be limited to feasible actions like removing impermissibly exclusionary ads when notified. They should not include disabling essential advertising tools for all users. The Court of Appeal’s overbroad approach would ultimately harm consumer access to targeted advertising.

With the foregoing in mind, we respectfully urge this Court to grant the pending petition for review. Careful examination of the Court of Appeal’s ruling will reveal it strays beyond the Act’s purpose and ignores collateral harms from overdeterrence. Guidance is needed on balancing antidiscrimination aims with the liberty interests of platforms and their users. This case presents an ideal vehicle for this Court to provide that guidance.

INTEREST OF AMICI CURIAE^[1]

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 to inform public policy debates and has longstanding expertise in antitrust law.  ICLE has an interest in ensuring that antitrust promotes the public interest by remaining grounded in sensible legal rules informed by sound economic analysis.

Amici also include fifteen scholars of antitrust, law, and economics at leading universities and research institutions across the United States.  Their names, titles, and academic affiliations are listed in Appendix A.  All have longstanding expertise in antitrust law and economics.

Amici respectfully submit that this brief will aid the Court in reviewing the order of dismissal by explaining that the district court properly held, on the pleadings, that the restraint at issue is ancillary and thus that per se treatment is inappropriate.  The restraint furthers Saks’s procompetitive goal of creating a strong and stable luxury brand through collaboration with the Brand Defendants.  Treating such a restraint as per se unlawful, as Plaintiffs ask this Court to do, would stifle the type of legitimate cooperation that facilitates output and would ultimately harm consumers.  Amici also explain why Plaintiffs and several of their amici, including the United States, make foundational errors of law and economics in arguing that ancillarity is an affirmative defense that may not be resolved on the pleadings.

INTRODUCTION AND SUMMARY OF ARGUMENT

Saks and the Brand Defendants are well-known luxury retail brands.  As luxury retailers, their business models depend on developing and maintaining a distinct, exclusive brand to differentiate their products from the lower-priced goods sold by mass-market retailers.  A primary way in which they define and protect their brands is by cultivating a premium shopping experience for customers that promotes “an atmosphere of exclusivity and opulence surrounding . . . luxury products.”  Compl. ¶ 33.  To that end, Saks and the Brand Defendants have for years collaborated through “store-within-a-store” arrangements: Saks allows the Brand Defendants to set up boutiques and concessions within Saks’s stores, which in turn helps all involved grow their customer base, augment their luxury brand status, and sell more products.  This “store-within-a-store” model not only expands customer product choice within a single retail establishment, resulting in a better shopping experience, but also creates additional jobs at Brand Defendants’ concessions in Saks’s stores.

Plaintiffs allege that the Brand Defendants agree, as part of their respective partnerships with Saks, not to hire Saks’s own luxury retail employees without the approval of a Saks manager or until six months after the employee leaves Saks.  Plaintiffs argue that these alleged no-hire provisions violate Section 1 of the Sherman Act.  The district court disagreed, concluding that the per se rule could not apply because the no-hire provisions were “ancillary” to a broader procompetitive collaboration between Saks and each of the Brand Defendants, and that Plaintiffs failed to plead a plausible claim under the rule of reason.  That decision is correct and should be affirmed.

First, the alleged no-hire agreements are ancillary to the arrangements between Saks and the Brand Defendants.  Saks invests heavily in its employees.  But without the no-hire provision, Saks would stand to lose those investments as the Brand Defendants could take advantage of their co-location within Saks’s stores to hire away Saks’s best workers, thereby free-riding on Saks’s training.  The alleged no-hire provisions eliminate that powerful economic disincentive and thereby facilitate brand-enhancing, procompetitive store-within-a-store arrangements.  That is all that is required for the agreements to be “ancillary.”  Plaintiffs’ (and their amici’s) insistence on a rigid two-prong test for ancillarity is not only at odds with economic logic but also out of step with this Circuit’s precedent—and, in any event, would not change the result here.

Second, the district court properly resolved ancillarity on the pleadings.  Ancillarity is a threshold inquiry decided at the earliest possible stage of a Section 1 case to determine whether the alleged facts justify departing from the default rule of reason standard.  That is precisely what the district court did here: based on Plaintiffs’ own allegations—including those regarding “a continual risk that the Brand Defendants would use their concessions in Saks stores to recruit employees” (Op. 32)—the district court ruled that the alleged restraints were ancillary and thus incompatible with per se condemnation.  Contrary to Plaintiffs’ argument, the district court did not improperly resolve any factual inferences.  The court considered the Complaint in its entirety and determined that Plaintiffs did not state a plausible per se claim, just as it was supposed to do before requiring the enormous expense that would result should this kind of “potentially massive factual controversy . . . proceed.”  Bell Atl. Corp. v. Twombly, 550 U.S. 544, 558 (2007).

ARGUMENT

I.              The Alleged Restraints Are Ancillary To Procompetitive Collaboration

The per se rule is reserved for the most pernicious and anticompetitive restraints.  Before condemning a restraint as per se unlawful, therefore, courts must “have amassed considerable experience with the type of restraint at issue” and be able to “predict with confidence that it would be invalidated in all or almost all instances.”  NCAA v. Alston, 141 S. Ct. 2141, 2156 (2021).  Reserving per se condemnation for that small category of restraints ensures that the antitrust laws do not inadvertently chill procompetitive conduct.  Ancillary restraints do not fit the per se mold because they have a “reasonable procompetitive justification, related to the efficiency-enhancing purposes of [a] joint venture.”  MLB Props., Inc. v. Salvino, Inc., 542 F.3d 290, 339 (2d Cir. 2008) (Sotomayor, J., concurring in the judgment).

Here, any purported no-hire agreements form a key plank of the broader leasing, concession, and distribution arrangements between Saks and the Brand Defendants.  Op. 30-32.  It is beyond dispute that these agreements are procompetitive.  They not only enhance Saks’s and the Brand Defendants’ ability to vigorously compete against other retailers and luxury brands (i.e., increasing output in markets for luxury products) but also create jobs (i.e., increase output in labor markets).  That places the restraint far beyond the per se rule, MLB, 542 F.3d at 339 (Sotomayor, J., concurring in the judgment); only the rule of reason can be used to determine whether the restraint “stimulat[es] competition that [is] in the consumer’s best interest” or has “anticompetitive effect[s] that are harmful to the consumer.”  Leegin Creative Leather Prods., Inc. v. PSKS, Inc., 551 U.S. 877, 886 (2007).[2]

                  A.            The Alleged No-Hire Agreements Are Facially Procompetitive

A restraint is ancillary where it “could have a procompetitive impact related to the efficiency-enhancing purposes” of a cooperative venture.  MLB, 542 F.3d at 340 (Sotomayor, J., concurring in the judgment); see Polk Bros., Inc. v. Forest City Enters., Inc., 776 F.2d 185, 188-89 (7th Cir. 1985) (restraint is ancillary if it “may contribute to the success of a cooperative venture that promises greater productivity and output”).  Where a restraint is deemed “ancillary to the legitimate and competitive purposes” of a venture, the restraint is presumptively “valid” and must be assessed under the rule of reason.  Texaco Inc. v. Dagher, 547 U.S. 1, 7 (2006).  There is a clear procompetitive rationale for the collaboration arrangement between Saks and the Brand Defendants: the arrangement allows customers to expand their choice in one-stop shopping, and the retailers to offer a wider range of high-end luxury goods.  And it creates a halo effect across the store-within-a-store through proximity and availability of multiple luxury brands.  All of this in turn promotes and enhances the luxury status of Saks and the Brand Defendants alike.  The alleged no-hire restraints enable and are ancillary to that larger endeavor.

As Plaintiffs allege, Defendants each derive much of their respective brand value from their ability to project a “luxury brand[] aura[],” which both entices customers and creates demand for Defendants’ goods “over other, lower-priced goods.”  Compl. ¶¶ 23, 26, 28.  For this reason, Defendants “go[] to great lengths to market” and otherwise “maintain[] their luxury brands’ auras.”  Id. ¶¶ 23, 26.  They “accomplish this feat,” in part, by ensuring that their brick-and-mortar stores provide a “luxury shopping experience[].”  Id. ¶ 27.  Defendants do that with sophisticated “décor and design” and premium “customer service” from skilled employees “who reflect their respective brand images and cultures.”  Id. ¶¶ 27-29.

Store-within-a-store arrangements further enhance the luxury brand shopping experience for both consumers and retailers.  In these arrangements, Saks allows the Brand Defendants to set up mini-stores or concessions within Saks’s large stores.  These arrangements, similar to those used by “[a]lmost all department store chains,” Kinshuk Jerath & Z. John Zhang, Store Within a Store, 47 J. Mktg. Rsch. 748, 748 (2010), are mutually beneficial and procompetitive.  The presence of the popular luxury brands helps draw brand-loyal customers into Saks, thus increasing foot traffic and broadening Saks’s customer reach—directly boosting sales output.  Compl. ¶ 28; see Jerath & Zhang, supra, at 756-57 (“The introduction of new products through stores within a store can bring new consumers to the store who want to purchase the focal product and also purchase other products.”).  The Brand Defendants benefit from access to Saks’s considerable customer base, Compl. ¶ 28, and their presence also makes possible cross-brand marketing opportunities.  Consumers benefit as well: they have access to a wider array of products, and have it all at hand in a single store.  And they have the benefit of workers highly trained with respect to the luxury goods they sell.  Id. ¶¶ 27-29, 32-34.

But there is a significant practical impediment to allowing stores-within-stores: employee raiding.  Saks invests heavily in its luxury retail employees, providing them with the “extensive training on service, selling, and product-knowledge” required to ensure that they are “knowledgeable about the particular products” for sale “as well as current trends.”  Compl. ¶¶ 32, 34.  Permitting the Brand Defendants to operate inside of Saks stores without restriction would put that investment in immediate danger.  The Brand Defendants would have every incentive to free-ride off of Saks’s investment, observing and hiring Saks’s highly trained luxury retail employees, thereby “tak[ing] advantage of the efforts [Saks] has expended in soliciting, interviewing, and training skilled labor” and “simultaneously inflicting a cost on [Saks] by removing an employee on whom [Saks] may depend.”  Id. ¶ 62.  This risk—and the mistrust it can create—disincentivizes the formation and maintenance of store-within-a-store agreements.

No-hire restraints solve this problem.  By imposing a narrow, time-limited, waivable restriction on the Brand Defendants’ ability to hire Saks employees, Compl. ¶ 92, the alleged no-hire agreements remove a roadblock from the “cooperation underlying the restraint,” which “has the potential to create the efficient production that consumers value,” Premier Elec. Constr. Co. v. Nat’l Elec. Contractors Ass’n, Inc., 814 F.2d 358, 370 (7th Cir. 1987).  In particular, the alleged no-hire restrictions help prevent free-riding by Brand Defendants on Saks’s training.  The agreement encourages Saks to invest in employee development, including by providing specific training on Brand Defendants’ products, and that investment enhances Saks’s ability to sell products from and compete against Brand Defendants’ stand-alone brick and mortar and online stores.  See, e.g., Gregory J. Werden, The Ancillary Restraints Doctrine After Dagher, 8 Sedona Conf. J. 17, 21 (2007).  “[W]ith the restraint,” Saks may “collaborate” with the Brand Defendants “for the benefit of its [customers] without ‘cutting [its] own throat.’”  Aya Healthcare Servs., Inc. v. AMN Healthcare, Inc., 9 F.4th 1102, 1110-11 (9th Cir. 2021) (quoting Polk Bros., 776 F.2d at 189).  As a result, the alleged no-hire restraints are “at least potentially reasonably ancillary to joint, efficiency-creating economic activities.”  Phillips v. Vandygriff, 711 F.2d 1217, 1229 (5th Cir. 1983); cf. Eichorn v. AT&T Corp., 248 F.3d 131, 146-47 (3d Cir. 2001) (“As an ancillary covenant not to compete, the no-hire agreement was reasonable in its restrictions on the plaintiffs’ ability to seek employment elsewhere.”).

The contrary conclusion—that the alleged no-hire restraints are not ancillary—risks stifling competition across the retail economy.  No-hire agreements are merely one of the many ancillary contractual restraints commonly used in store-within-a-store partnerships (exemplified by, for instance, the well-known collaborations between Target and Starbucks or Best Buy and Samsung) to preserve brand integrity, guard against misuse of store space, and safeguard investments in specialized training.  By solving for risks such as employee raiding or damage to property, these restrictions instill confidence in both parties, facilitating the creation of these cooperative ventures in the first place.  Categorizing the alleged no-hire provisions here as per se unlawful could chill a whole spectrum of reasonable ancillary restraints, undermining the careful balance that store-within-a-store arrangements aim to maintain and inhibiting market innovation.  That would be bad for potential employees, who would lose the opportunity to work at stores-within-stores, as well as for consumers, who would lose the convenient access to goods in-store concessions provide.

                   B.            The Rigid Two-Prong Test Advanced By Plaintiffs And Their Amici Is Not The Law, And The Alleged Restraints Here Satisfy It In Any Event

Plaintiffs and their amici resist ancillarity by, in part, insisting upon application of a strict and formalistic test not found in the law of this Circuit or any other.  In their view, an ancillary restraint must be both (1) “subordinate and collateral to a separate legitimate transaction” and (2) “reasonably necessary to achiev[e] that transaction’s procompetitive purpose.”  AOB 34-35.  This rigid two-step test is not the law in this Circuit.  But even if it were, Plaintiffs and amici misconstrue the second prong, improperly transforming it into a strict necessity standard that no circuit has adopted.  Consistent with their evident procompetitive potential, the alleged restraints here amply satisfy the actual test.

Although some courts have moved toward a delineated two-prong standard, this Court has not.  This Court’s leading opinion on ancillarity is then-Judge Sotomayor’s influential concurrence in MLB, in which she observed that a restraint is ancillary where it is “reasonably necessary to achieve any of the efficiency-enhancing benefits of a joint venture.”  542 F.3d at 338 (Sotomayor, J., concurring in the judgment).  She noted no other requirements, invoking Judge Easterbrook’s similar formulation in Polk Bros. that a restraint is ancillary where it “may contribute to the success of a cooperative venture that promises greater productivity and output.”  Id.; Polk Bros., 776 F.2d at 189; see Rothery Storage & Van Co. v. Atlas Van Lines, Inc., 792 F.2d 210, 229 (D.C. Cir. 1986) (restraint is ancillary when it “appears capable of enhancing the group’s efficiency”).  That approach in turn traces all the way to then-Judge Taft’s seminal United States v. Addyston Pipe & Steel Co. decision, which assessed ancillarity using this same flexible formulation.  See 85 F. 271, 281 (6th Cir. 1898).

Even if the two-prong test advanced by Plaintiffs and their amici did apply, however, they misconstrue the second prong by paying only lip service to a “reasonably necessary” standard and in reality asking this Court to impose a “strictly necessary” test.  Instead of asking whether the restraint “promoted enterprise and productivity”—which is all that is required for a restraint to be “reasonably necessary,” Aya, 9 F.4th at 1110-11—Plaintiffs would require Defendants to show that the “restraint [is] necessary to achieve the business relationship,” AOB 36, such that in its absence, “Saks would terminate or . . . alter its purported collaborative relationships,” NY Br. 29.

No court of appeals has embraced this strict-necessity standard.  In Medical Center at Elizabeth Place, LLC v. Atrium Health System, for instance, the Sixth Circuit considered and rejected it, holding that requiring a defendant to show that a restraint “is necessary” is “too high a standard to determine what qualifies as ‘reasonable.’”  922 F.3d 713, 725 (6th Cir. 2019); see also id. at 726 (observing Judge Sotomayor’s MLB concurrence “categorically rejected” a strict necessity test).  Rather, an ancillary restraint “need not be essential, but rather only reasonably ancillary to the legitimate cooperative aspects of the venture” because “there exists a plausible procompetitive rationale for the restraint.”  Id. (quotation marks omitted).  The Ninth Circuit similarly rejected the United States’ attempt to advance this standard, and instead held in Aya that a no-hire restraint was “properly characterized as ancillary” where it “promoted enterprise and productivity at the time it was adopted.”  9 F.4th at 1111.  And the United States and a different set of plaintiffs recently argued for a strict-necessity test in the Seventh Circuit.  See Br. for the U.S. and the FTC as Amici Curiae Supporting Neither Party at 26, Deslandes v. McDonald’s USA, LLC, Nos. 22-2333 & 22-2334 (7th Cir. Nov. 9, 2022) (arguing no-hire agreement was not ancillary because it “was not necessary to encourage franchisees to sign” franchising agreements).  The panel declined to adopt it, adhering instead to the Polk Bros. test.  See Deslandes v. McDonald’s USA, LLC, 81 F.4th 699, 703 (7th Cir. 2023).

All of these decisions make sense.  The per se rule applies only when a challenged restraint is obviously and clearly anticompetitive, and a restraint that is plausibly part of a procompetitive venture should be judged by “the facts peculiar to the business to which the restraint is applied.”  Bd. of Trade of Chi. v. United States, 246 U.S. 231, 238 (1918).  A contrary decision would discourage competition; strict necessity is not only an unrealistic requirement, as businesses make these decisions ex ante, but also would require them to constantly recalibrate their policies.  The result would be that firms forego potentially procompetitive collaborations, chilling innovative policies and business models.  See Werden, supra, at 23-24 (comprehensive analysis by DOJ economist rejecting strict-necessity test).

Nor is there any legal or logical basis for Plaintiffs’ made-up “tailor[ing]” prong—that a “restraint must be ‘tailored’ to a legitimate objective to qualify as ancillary.”  AOB 35.  Courts routinely reject any “reasonabl[e] tailor[ing]” requirement, because that phrase would not “carr[y] a materially different meaning than ‘reasonably necessary’” and because a restraint “need not satisfy a less-restrictive-means test.”  Aya, 9 F.4th at 1111 & n.5.  A tailoring analysis can be part of the rule-of-reason framework employed after a restraint is deemed ancillary, but it has no role in the ancillarity inquiry itself, which evaluates whether a restraint “should be reviewed under the rule of reason” in the first place.  MLB, 542 F.3d at 341 (Sotomayor, J., concurring in the judgment).  The flaw in Plaintiffs’ argument is underscored by the only case they cite to support their purported tailoring requirement, which did not even involve ancillarity, but instead analyzed whether there was a less restrictive alternative under the rule of reason.  See NCAA v. Bd. of Regents of Univ. of Okla., 468 U.S. 85, 117 (1984); see also Aya, 9 F.4th at 1111 (“[T]he less restrictive alternative analysis falls within the rule-of-reason analysis, not the ancillary restraint consideration.”).

Properly interpreted to require only “reasonable necessity,” the two-prong test is satisfied here on the face of the Complaint.  The alleged restraint is “subordinate and collateral” to a broader venture in which Saks permits the Brand Defendants to “sell their goods and apparel” with Saks’s stores.  Compl. ¶ 21.  Although the United States argues that the Complaint “contains no allegations of any connection . . . between the alleged conspiracy and those business relationships,” U.S. Br. 15-16, that is not correct: the Brand Defendants operate “concessions at Saks stores,” Compl. ¶ 21, and Saks employees receive brand-specific training, id. ¶ 160.  As the district court held, Op. 34 n.22, the alleged restraint prevented the Brand Defendants from hiring Saks employees who sold the Brand Defendants’ merchandise, thereby protecting Saks’s training investments, see Compl. ¶¶ 156-61, 187-91, increasing the attractiveness of the broader collaboration, and promoting mutual trust between the parties, see Rothery Storage, 792 F.2d at 224 (restraint that “serves to make the main transaction more effective in accomplishing its purpose” is “subordinate and collateral”).

Plaintiff Susan Giordano’s allegations about her own experience demonstrate that this alleged restraint is ancillary.  Giordano was a Saks employee at Saks’s Loro Piana boutique for “18 months,” during which time she became “familiar[] with Loro Piana’s . . . merchandise.”  Compl. ¶¶ 157, 160.  Giordano sought employment at a standalone Loro Piana boutique, explaining that she “would surely be an asset” because of her familiarity with Loro Piana’s product gained from Saks’s training.  Id. ¶¶ 156-61.  But the no-hire restraint allegedly prevented Loro Piana from hiring Giordano, id. ¶ 161, “ensur[ing] that [Saks] [did] not lose its personnel during the collaboration” with Brand Defendants, Aya, 9 F.4th at 1110.  Courts have found just these sorts of no-hire agreements to facilitate “procompetitive collaboration” to be “reasonably necessary.”  Id.; cf. Bogan v. Hodgkins, 166 F.3d 509, 515 (2d Cir. 1999) (rejecting per se treatment for no-hire agreements).

The United States’ arguments to the contrary are unavailing.  It argues that the alleged no-hire agreements go beyond solicitation at the concessions themselves, barring the Brand Defendants from hiring even Saks employees who independently apply or approach the Brand Defendants for a job.  U.S. Br. 19.  But the no-hire agreements’ purpose, to protect against risks that employees would leave for a collaborating brand located inside their own store, applies equally regardless of whether an employee is solicited by or independently approaches a competitor.  In both instances, Saks invested in brand-specific employee training, see Compl. ¶¶ 32, 34, 156, that the no-hire agreement protects from the unique exposure of a store-within-a-store.

The United States also suggests that the restraint is not reasonably necessary because it applies to “any brand [or designer company] carried by Saks” rather than just brands that maintain concession stands.  U.S. Br. 16, 19.  But a restraint “need not satisfy a less-restrictive-means test,” Aya, 9 F.4th at 1111; regardless, Saks employees receive detailed training on all luxury brands sold in the stores, even those that do not maintain concession stands, see Compl. ¶ 34.  The alleged no-hire agreement notably does not extend to the many luxury brands whose goods are not “carried by Saks,” id. ¶ 175, leaving Saks employees free to take their talents to those competing employers or to other retailers of luxury goods.  And the United States’ suggestion that the duration of the agreement is too long, U.S. Br. 19, ignores that employees receive continuous training to remain “knowledgeable about the particular products [sold] . . . as well as current trends,” Compl. ¶ 34 (emphasis added).  If employees could leave their employment with Saks and immediately join the competitor, then the alleged restraint would have no effect at all, and Saks would lose the incentive to invest in ongoing specialized training regarding competitor brands.

II.            The District Court Properly Decided Ancillarity On The Pleadings

Nothing in the antitrust laws prohibits a district court from resolving ancillarity on the pleadings, and the court’s decision to do so here was procedurally proper and analytically sound.  Determining whether a challenged restraint is “naked” or “ancillary” is a threshold inquiry for a Section 1 claim because “[t]his all-important classification largely determines the course of subsequent legal evaluation of [the] restraint.”  Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application, ¶ 1904 (5th ed., 2023 Cum. Supp.).  Put another way, resolving ancillarity at the outset of the case dictates the mode of analysis employed by the court: naked restraints are subject to per se treatment, while ancillary restraints are analyzed under the rule of reason.

This does not mean that ancillarity must be resolved at the pleadings—depending on the circumstances, it may be resolved after the pleadings but before summary judgment, at summary judgment, or even at trial.  See In re HIV Antitrust Litig., 2023 WL 3088218, at *23 (N.D. Cal. Feb. 17, 2023) (summary judgment); N. Jackson Pharmacy, Inc. v. Caremark RX, Inc., 385 F. Supp. 2d 740, 743 (N.D. Ill. 2005) (pre-summary judgment Rule 16 motion).  Rather, ancillarity is a threshold issue that sets the stage for the analysis that follows, and deciding it at the pleadings stage permits defendants to defeat meritless claims before undergoing costly discovery.

The district court properly resolved the question on a motion to dismiss here because Plaintiffs’ own allegations made clear that the alleged no-hire agreements were ancillary.  Plaintiffs and their amici make two arguments: first, that ancillarity cannot be resolved on the pleadings, and second, that the district court improperly resolved facts in Defendants’ favor.  Neither argument persuades.

                  A.            Ancillarity Is A Threshold Inquiry, Not An Affirmative Defense

Courts analyzing Section 1 claims must first determine the proper framework to apply: the per se rule or the rule of reason (or, in some cases, an abbreviated “quick look” analysis).  See Leegin, 551 U.S. at 886-87.  To make that determination, “[a] court must distinguish between ‘naked’ restraints, those in which the restriction on competition is unaccompanied by new production or products, and ‘ancillary’ restraints, those that are part of a larger endeavor whose success they promote.”  MLB, 542 F.3d at 339 (Sotomayor, J., concurring in the judgment) (quoting Polk Bros., 776 F.2d at 188).  “This all-important classification largely determines the course of subsequent legal evaluation of any restraint.”  Areeda & Hovenkamp, supra, ¶ 1904; see Thomas B. Nachbar, Less Restrictive Alternatives and the Ancillary Restraints Doctrine, 45 Seattle U. L. Rev. 587, 634 (2022) (“In order to do any real work, the ancillary restraints doctrine has to precede the rule of reason.”); Herbert Hovenkamp, The Rule of Reason, 70 Fla. L. Rev. 81, 140 (2018) (“The ancillary restraints doctrine is not a comprehensive method for applying the rule of reason, but rather an early stage decision about which mode of analysis should be applied.”).  Thus, ancillarity is a gating inquiry.  By determining at the outset of the case whether a challenged restraint is naked or ancillary, the court ensures it applies the proper analytical framework.

Because this determination guides how the parties conduct discovery and try the case, it is important to decide ancillarity at the earliest possible stage.  This avoids “expensive pretrial discovery” on the wrong questions and issues.  And it avoids discovery altogether in cases that do not state a claim and should never proceed past the pleadings.  Limestone Dev. Corp. v. Vill. of Lemont, 520 F.3d 797, 803 (7th Cir. 2008) (noting importance of carefully evaluating antitrust claims at pleading stage “lest a defendant be forced to conduct expensive pretrial discovery in order to demonstrate the groundlessness of the plaintiff’s claim” (citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 558-59 (2007))).

Treating ancillarity as a gating inquiry also is consistent with the Supreme Court’s admonition that per se treatment must be confined to a narrow class of cases.  As the Court has explained, “the per se rule is appropriate only after courts have had considerable experience with the type of restraint at issue and only if courts can predict with confidence that it would be invalidated” under the rule of reason.  Leegin, 551 U.S. at 886-87; Dagher, 547 U.S. at 5 (“Per se liability is reserved for only those agreements that are so plainly anticompetitive that no elaborate study of the industry is needed to establish their illegality.” (quotation marks omitted)).  That predictive confidence must be rooted in the “demonstrable economic effect” of the restraint at issue, not a plaintiff’s suspicion that the restraint is harmful.  Leegin, 551 U.S. at 887.  This is a high bar.  Only when a restraint is “so obviously lacking in any redeeming pro-competitive values” may courts apply the per se rule.  Cap. Imaging Assocs., P.C. v. Mohawk Valley Med. Assocs., Inc., 996 F.2d 537, 542 (2d Cir. 1993).

Because per se analysis is warranted only when justified by “demonstrable economic effect,” resolving the issue of ancillarity on the pleadings ensures that plaintiffs cannot invoke per se treatment on mere say-so.  The ancillarity inquiry, by definition, considers the relationship of the challenged restraint to the parties’ business collaboration—that is, the inquiry explores the likely “economic effect” of the restraint within the context of commercial realities.  That is precisely what the Supreme Court requires before expanding the per se rule into new frontiers.  Broad. Music, Inc. v. Columbia Broad. Sys., Inc., 441 U.S. 1, 19 n.33 (1979) (“[T]he per se rule is not employed until after considerable experience with the type of challenged restraint.”); Bogan, 166 F.3d at 514 (“The Supreme Court is slow to . . . extend per se analysis to restraints imposed in the context of business relationships where the economic impact of certain practices is not immediately obvious.” (quotation marks omitted)).

If ancillarity could be resolved only after the pleadings stage, as Plaintiffs and their amici urge, then a Section 1 plaintiff could survive dismissal simply by invoking the per se rule without regard for the restraint’s “economic effect” or the courts’ ability to “predict with confidence that [the restraint] would be invalidated.”  Leegin, 551 U.S. at 886-87.  A simple example underscores the absurdity of that rule: ever since they were recognized in Addyston Pipe as axiomatic ancillary restraints, no-hire provisions are commonly included in agreements for the sale of a business.  The approach proposed would require litigation through discovery to decide if such a provision were ancillary.

Moreover, neither the federal courts nor the academy have amassed sufficient experience with this subject to allow default per se treatment.  Indeed, the only study that attempted to analyze the relevant economic considerations in a systematic way concluded that eliminating no-hire provisions “causes minimal reductions in job concentration and no increase in wages.”  Daniel S. Levy et al., No-Poaching Clauses, Job Concentration and Wages: A Natural Experiment Generated by a State Attorney General, Advanced Analytical Consulting Group, Inc., at 1 (Jan. 23, 2020).  That inconclusive literature falls far short of justifying a rule that would effectively extend per se treatment to all no-hire agreements.

If anything, the economic incentives weigh strongly in favor of deciding ancillarity at the earliest possible stage allowed by the record.  This is because a rule prohibiting courts from deciding ancillarity at the pleadings stage would be a free pass to discovery (and the “potentially enormous expense” associated with it), which would “push cost-conscious defendants to settle even anemic [Section 1] cases.”  Twombly, 550 U.S. at 559.  That pressure, in turn, would distort normal business incentives—faced with the prospect of huge discovery costs from meritless claims, rational businesses would understandably refrain from entering into legitimate, procompetitive collaborations.  Plaintiffs and their amici offer no good reason for adopting a rule that would undercut the very efficiency-enhancing purposes antitrust law is meant to advance.  See Morrison v. Murray Biscuit Co., 797 F.2d 1430, 1437 (7th Cir. 1986) (“The purpose of antitrust law, at least as articulated in the modern cases, is to protect the competitive process as a means of promoting economic efficiency.”); see also MLB, 542 F.3d at 339 (Sotomayor, J., concurring in the judgment) (restraints do not receive per se treatment when they have a “reasonable procompetitive justification, related to the efficiency-enhancing purposes of [a] joint venture”).

The United States asserts that ancillarity is only a “defense” to per se illegality, rather than a threshold inquiry to determine whether a case calls for departing from the rule of reason.  U.S. Br. 12-13.  None of the United States’ cases, however, limit the ancillarity restraints doctrine in this way.  The lone Second Circuit case the United States cites was a criminal matter where the standard applied to motions to dismiss is far more lenient and deferential to the United States than that mandated for civil cases in Twombly.  In such cases, courts treat the government’s characterization of conduct as within the four corners of a recognized per se theory as sufficient for indictment purposes.  See United States v. Aiyer, 33 F.4th 97, 116 (2d Cir. 2022) (indictments need only “contain[] the elements of the offense charged” and enable defendant to enter plea).  Moreover, in that case, the defendant had not even challenged on appeal the district court’s conclusion that the indictment at issue adequately alleged a per se antitrust violation.  See id. at 116-23.  The panel never characterized ancillarity as a “defense.”  See id.

The same goes for Blackburn and Board of Regents.  Although the courts in those cases ultimately concluded the restraints at issue were not ancillary, neither case held that ancillarity was only a defense.  Blackburn v. Sweeney, 53 F.3d 825, 828-29 (7th Cir. 1995); Bd. of Regents of Univ. of Okla. v. NCAA, 707 F.2d 1147, 1153-56 (10th Cir. 1983).  Freeman is similarly off base.  While the court there offhandedly referred to the defendant’s overall argument against the antitrust claim as a “defense,” it did so after the ancillarity discussion.  Freeman v. San Diego Ass’n of Realtors, 322 F.3d 1133, 1151-52 (9th Cir. 2003).  The court did not use the term with specific reference to ancillarity, and in any event its use of “defense” was not meant in the same way that Plaintiffs and their amici use it—that is, as an issue that cannot be resolved at the outset of the case.  AOB 39; U.S. Br. 12-13, 15.  In short, none of the government’s cases hold that ancillarity is strictly a defense or is otherwise immune from resolution on the pleadings.

The Seventh Circuit’s recent decision in Deslandes doesn’t advance the government’s cause either.  Although the court in Deslandes summarily stated that “the classification of a restraint as ancillary is a defense,” 81 F.4th at 705, plaintiffs can plead themselves out of court, Hadid v. City of New York, 730 F. App’x 68, 71 (2d Cir. 2018), which is what Plaintiffs have done here.  Nor should it be followed: the Seventh Circuit cited no case law and offered no analysis to support its bald assertion.  Deslandes, 81 F.4th at 705.  And, as explained, any suggestion that ancillarity can be treated only as a defense would undo the clear demarcation between the rule of reason and per se treatment.  If courts can’t evaluate ancillarity at the outset, restraints that should be presumptively analyzed under the rule of reason would instead be presumptively treated as per se illegal.  That result is plainly inconsistent with the Supreme Court’s antitrust precedents.

In a related argument, Plaintiffs contend that ancillarity cannot be decided on the pleadings, but instead “requires discovery.”  AOB 39.  But that also is wrong.  “In considering a motion to dismiss, the court is not required to don blinders and to ignore commercial reality.”  Car Carriers, Inc. v. Ford Motor Co., 745 F.2d 1101, 1110 (7th Cir. 1984), abrogated on other grounds by Schmees v. HC1.COM, Inc., 77 F.4th 483 (7th Cir. 2023).  Consistent with this principle, courts routinely resolve ancillarity on the pleadings where it is clear from the complaint that the restraint may be procompetitive.  For example, in Helmerich & Payne International Drilling Co. v. Schlumberger Technology Corp., the court dismissed a restraint of trade claim at the pleading stage where “the pleadings in [the] case [made] clear” that the challenged non-solicitation provision was “ancillary” to “a larger business transaction between two independent parties.”  2017 WL 6597512, at *4 (N.D. Okla. Dec. 26, 2017).  Similarly, the court in Gerlinger v. Amazon.Com, Inc. determined that a purported price-fixing arrangement between Borders and Amazon was “ancillary” to the companies’ broader website hosting agreement, in part because the “context in which the agreement was entered into” confirmed its procompetitive potential.  311 F. Supp. 2d 838, 848-49 (N.D. Cal. 2004).  The court reached this conclusion on a motion for judgment on the pleadings.  Id.  Other courts have similarly decided ancillarity on the pleadings alone.  See Kelsey K. v. NFL Enters. LLC, 2017 WL 3115169, at *4 (N.D. Cal. July 21, 2017) (motion to amend), aff’d, 757 F. App’x 524, 526 (9th Cir. 2018); Hanger v. Berkley Grp., Inc., 2015 WL 3439255, at *5 (W.D. Va. May 28, 2015) (motion to dismiss); Caudill v. Lancaster Bingo Co., 2005 WL 2738930, at *3-6 (S.D. Ohio Oct. 4, 2005) (motion for judgment on the pleadings).  Contrary to Plaintiffs’ argument, the district court’s pleading-stage ancillarity ruling was entirely proper.

                   B.            The District Court Did Not Reach Past Plaintiffs’ Allegations

Ancillarity can support dismissal when it is “apparent from the allegations in the complaint,” as even the United States acknowledges.  U.S. Br. 15.  Here, the district court’s ancillarity ruling was amply supported by Plaintiffs’ own allegations.  Plaintiffs allege that Saks and the Brand Defendants collaborate in the sale of luxury goods by partnering to sell the Brand Defendants’ goods both directly at Saks stores and through concessions within them.  Compl. ¶¶ 21, 28; see supra, at 4-10.  By cooperating in this way, Saks and the Brand Defendants can leverage each other’s employees and brands to create a distinct “shopping experience for customers”—that is, the “atmosphere of exclusivity and opulence surrounding . . . luxury products,” Compl. ¶ 33, needed to promote “demand for[] luxury goods over other, lower-priced goods,” id. ¶ 23.  The upshot is a procompetitive collaboration that, in the words of Polk Bros., “promises greater productivity and output.”  776 F.2d at 189.

The district court also properly relied on the Complaint to conclude that “absent the no-hire agreement, there would be a continual risk that the Brand Defendants would use their concessions in Saks stores to recruit [Saks] employees.”  Op. 32 (citing Compl. ¶¶ 56-57, 83).  Minimizing the risk of such “free rid[ing]” is a common, efficiency-enhancing feature of ancillary restraints.  Rothery Storage, 792 F.2d at 229 (restraints were ancillary where they “preserve[d] the efficiencies of the [collaboration] by eliminating the problem of the free ride”); Polk Bros., 776 F.2d at 190 (agreement was ancillary to a joint sales venture where it limited the potential that one retailer would free ride on the sales efforts of another).  That includes procompetitive restraints on employee movement.  Aya, 9 F.4th at 1110 (restraint was ancillary to business collaboration where it guarded against risk of one party “proactively raiding . . . employees” of another party).

Notably, the risk of free riding wasn’t hypothetical: as the district court pointed out, the Complaint specifically alleges that Plaintiff Giordano sought to leverage the experience she acquired while working at the Loro Piana boutique as a Saks employee to seek employment with Loro Piana.  Op. 34 n.22.  The district court also highlighted Plaintiffs’ allegations that without the no-hire agreements, Brand Defendants such as Louis Vuitton could “take advantage” of Saks’s hiring efforts by recruiting Saks employees away from Saks after that company had already invested time and money to recruit and train its personnel.  Op. 32; Compl. ¶¶ 62-63; see Compl. ¶ 53 (alleging that “a Defendant would save on training costs and receive the immediate benefit of a well-trained, motivated salesperson” by hiring “from one of its rivals”).  This poaching, according to Plaintiffs, would “inflict[] a cost on [Saks] by removing an employee on whom [Saks] may depend.”  Compl. ¶ 62.  Thus, Plaintiffs’ own allegations demonstrate the alleged no-hire agreement is ancillary.  By addressing the free-rider problem, the agreement eliminates an externality “that may otherwise distort the incentives of [the Brand Defendants] and limit the potential efficiency gains of [the collaboration].”  MLB, 542 F.3d at 340 (Sotomayor, J., concurring in the judgment).  Nothing more was required to resolve ancillarity on the pleadings.

Plaintiffs and their amici argue the district court erred by drawing factual inferences in favor of Saks, rather than Plaintiffs.  AOB 37-40; N.Y. Br. 26-27.  According to Plaintiffs, ancillarity was a “contested factual issue” that could be resolved in Saks’s favor only by improperly rejecting Plaintiffs’ allegations.  AOB 37-38.  Plaintiffs’ argument is misplaced.

“Determining whether a complaint states a plausible claim for relief [is] a context-specific task that requires the reviewing court to draw on its judicial experience and common sense.”  Jessani v. Monini N. Am., Inc., 744 F. App’x 18, 19 (2d Cir. 2018) (quoting Ashcroft v. Iqbal, 556 U.S. 662, 679 (2009)).  As part of that exercise, courts consider “a host of considerations: the full factual picture presented by the complaint, the particular cause of action and its elements, and the existence of alternative explanations so obvious that they render plaintiff’s inferences unreasonable.”  Fink v. Time Warner Cable, 714 F.3d 739, 741 (2d Cir. 2013); see Boca Raton Firefighters & Police Pension Fund v. Bahash, 506 F. App’x 32, 35 (2d Cir. 2012).

That is precisely what the district court did here.  It considered the “full factual picture presented by the complaint”—including the nature of the Defendants’ business relationship and the role of the no-hire agreement in the context of that relationship—to conclude that the alleged no-hire agreement was ancillary to a procompetitive collaboration.  Fink, 714 F.3d at 741 (emphasis added); Op. 28-34.  And in doing so, the court properly demonstrated that Plaintiffs’ own allegations precluded per se treatment.  See Weisbuch v. Cnty. of Los Angeles, 119 F.3d 778, 783 n.1 (9th Cir. 1997) (“Whether [a] case can be dismissed on the pleadings depends on what the pleadings say.”).  Plaintiffs can’t avoid the consequences of their allegations by truncating the court’s properly holistic review of the pleadings—indeed, “[i]f the pleadings establish facts compelling a decision one way, that is as good as if depositions and other expensively obtained evidence on summary judgment establishes the identical facts.”  Id.

The district court’s ancillarity ruling was sound.

CONCLUSION

For the foregoing reasons, this Court should affirm.

[1] All parties have consented to the filing of this brief.  Pursuant to Federal Rule of Appellate Procedure 29(a)(4)(E), counsel for ICLE represents that no counsel for any of the parties authored any portion of this brief and that no entity, other than amici curiae or their counsel, monetarily contributed to the preparation or submission of this brief.

[2] The alleged no-hire agreements also do not fit the per se mold because they are part of a dual-distribution relation in which the Brand Defendants sell their products to end consumers through “their own standalone boutiques” as well as through distributors, “including Saks.”  Compl. ¶ 21; see Beyer Farms, Inc. v. Elmhurst Dairy, Inc., 35 F. App’x 29, 29-30 (2d Cir. 2002) (holding that a restraint was “subject to scrutiny under the ‘rule of reason’” because the complaint alleged a “dual-distributorship relationship”); Elecs. Commc’ns Corp. v. Toshiba Am. Consumer Prods., Inc., 129 F.3d 240, 243 (2d Cir. 1997) (similar).

PORTLAND, Ore. (Nov. 15, 2023) – The International Center for Law & Economics (ICLE) offers the following statement from ICLE Director of Innovation Policy Kristian Stout in response to today’s Federal Communications Commission (FCC) vote to adopt “digital discrimination” rules pursuant to the Biden administration’s larger digital equity plan and its interpretation of the relevant provisions of the Infrastructure Investment and Jobs Act (IIJA):

The FCC has unfortunately chosen to move forward with highly controversial provisions of its digital-discrimination rulemaking, including the adoption of a disparate-impact standard and an extension of the rules to cover broadband service characteristics, such as pricing and quality. Such rules will have a host of unintended consequences, including introducing de facto rate regulation, which the FCC has historically eschewed. The move is particularly curious given the Supreme Court’s emerging “major questions” jurisprudence, which will pose a major obstacle for the FCC to implement these rules.

For more on the topic, see ICLE’s reply comments to the FCC, as well as this ex parte letter and this “tl;dr” explainer. To schedule an interview with Kristian about the FCC’s planned regulations, contact ICLE Media and Communications Manager Elizabeth Lincicome at [email protected] or (919) 744-8087.

We thank the International Trade Administration (ITA), the National Institute of Standards and Technology (NIST) and the U.S. Patent and Trademark Office (USPTO) for this opportunity to comment on its call for evidence concerning a new framework for standard-essential patents.[1] The International Center for Law and Economics (ICLE) is a nonprofit, nonpartisan research center whose work promotes the use of law & economics methodologies to inform public-policy debates. We believe that intellectually rigorous, data-driven analysis will lead to efficient policy solutions that promote consumer welfare and global economic growth. ICLE’s scholars have written extensively on competition, intellectual property, and consumer-protection policy.

In this comment, we express concerns about global regulatory developments in the standard-essential patent (SEP) industry. The European Union is in the process of considering legislation that would fundamentally alter the landscape of global standards setting, making it more difficult for inventors to enforce their intellectual-property rights.[2] Not only will this legislation have profound ramifications for companies located all over the globe but—as the USPTO’s call for comments recognizes—the EU risks kicking off a global race to the bottom in regulating SEPs that will ultimately harm innovation and slow the diffusion of groundbreaking technologies.

We are concerned that a tit-for-tat response intended to counteract bad policies in the EU (and among other allied nations) is doomed to do more harm than good. Erecting what amount to protectionist barriers—even if in response to similar regulations abroad—would diminish U.S. interests, as well as those of our partners. Instead, the agencies should be seeking opportunities to influence the policy decisions made in foreign jurisdictions, in the hope that those entities will pursue better policies.

For obvious reasons, the way intellectual-property disputes are resolved has tremendous ramifications for firms that operate in standard-reliant industries. Not only do many of the firms in this space derive a large share of their revenue from patents but, perhaps more importantly, the prospect of litigation dictates how firms structure the transfer of intellectual-property assets. In simple terms, ineffectual judicial remedies for IP infringements and uncertainty concerning the resolution of IP disputes discourage firms from concluding license agreements in the first place.

The key role that IP plays in these industries should impel policymakers to proceed with caution. By virtually all available metrics, the current system works. The development of innovative technologies through standards development organizations (SDOs) has led to the emergence of some of the most groundbreaking technologies that consumers use today;[3] and recent empirical evidence suggests that many of the alleged ills that have been associated with the overenforcement of intellectual-property rights simply fail to materialize in industries that rely on standard-essential patents.[4]

At the same time, “there is no empirical evidence of structural and systematic problems of holdup and royalty stacking affecting standard-essential patent (“SEP”) licensing.”[5] Indeed, “[t]he notion that implementers in such innovation–driven industries are being suffocated by an insurmountable patent royalty stack has turned out to be nothing more than horror fiction.”[6] Yet, without a sound basis, the anti-injunctions approach increasingly espoused by policymakers unnecessarily “adds a layer of additional legal complexity and alters bargaining processes, unduly favoring implementers.”[7]

Licensing negotiations involving complex technologies are legally intricate. It is simply not helpful for a regulatory body to impose a particular vision of licensing negotiations if the goal is more innovation and greater ultimate returns to consumers. Instead, where possible, policy should prefer allowing parties to negotiate at arm’s length and to resolve disputes through courts. In addition to maintaining the sometimes-necessary remedy of injunctive relief against bad-faith implementers, this approach allows courts to explore when injunctive relief is appropriate on a case-by-case basis. Thus, over the course of examining actual cases, courts can refine the standards that determine when an injunctive remedy is inappropriate. Indeed, the very exercise of designing ex ante rules and guidelines to inform F/RAND licensing is antagonistic to optimal policymaking, as judges are far better situated and equipped to make the necessary marginal adjustments to the system.

Against this backdrop, our comments highlight several factors that should counsel preserving the rules that currently govern SEP-licensing agreements:

To start, the SEP space is far more complex than many recognize. Critics often assume that collaborative standards development creates significant scope for opportunistic behavior—notably, patent holdup. The tremendous growth of SEP-reliant industries and market participants’ strong preference for this form of technological development, however, suggest these problems are nowhere near as widespread as many believe.

Second, it is important not to overlook the important benefits conferred by existing IP protections. This includes the advantages inherent in pursuing injunctions rather than damages awards.

Third, weakening the protections afforded to SEP holders would also erode the West’s technological leadership over economies that are heavily reliant on manufacturing, and whose policymakers routinely undermine foreign firms’ intellectual-property rights. In short, while IP promotes innovation, weakened patent protection has second-order effects that are often overlooked, such as ceding advantages to China’s manufacturing sector and thereby exacerbating U.S.-China tensions.

Fourth, while mandated transparency in SEP negotiations may appear beneficial, the reality is more complex, as disclosure requirements can have mixed effects. Further, transparency mandates would likely require government interventions, such as essentiality checks, which can be very costly.

Finally, collective SEP rate-setting raises antitrust issues that stem from firms’ need to share sensitive data in order to determine a standard’s value. Vertically integrated SEP holders setting collective royalties on the inputs they manufacture could enable price-fixing and collusion. Safeguards like third-party mediation in patent pools may be needed so that joint SEP rate negotiation does not violate antitrust rules barring competitors from fixing prices.

I.        Regulatory Developments in Foreign Jurisdictions

In their call for comments, the agencies essentially ask whether regulatory developments in foreign jurisdictions threaten U.S. technological leadership in industries that rely on standard-essential patents and, if so, how the United States should respond:

Do the intellectual property rights policies of foreign jurisdictions threaten any of U.S. leadership in international standard setting, U.S. participation in international standard setting, and/or the growth of U.S. SMEs that rely on the ability to readily license standard essential patents?

If responding affirmatively to question 1, what can the Department of Commerce do to mitigate the effects of any adverse foreign policies relating to intellectual property rights and standards? Please clearly identify any such adverse foreign policies with specificity.[8]

Recent regulatory developments in the European Union loom large over the agencies’ two questions. On April 27, the European Commission published its Proposal for a Regulation on Standard Essential Patents (“SEP Regulation”). The SEP Regulation’s proclaimed aims are to ensure that end users—including small businesses and EU consumers—benefit from products based on the latest standardized technologies; make the EU attractive for standards innovation; and encourage both SEP holders and implementers to innovate in the EU, make and sell products in the EU, and be competitive in non-EU markets.[9]

While we share the agencies’ concern, responding to this foreign legislation (and other international responses that are likely to arise) by enacting similar policies would only exacerbate the situation and further erode U.S. technological leadership. In fact, several of the EU legislation’s shortcomings that would be rendered more destructive if the United States responded in kind.

As ICLE-affiliated scholars have explained in comments on the draft European legislation,[10]  the available evidence does not support a finding of market failure in SEP-licensing markets that would justify intrusive regulatory oversight. Instead, the Commission’s own evidence points to the low incidence of SEP litigation and no systemic negative effects on SEP owners and implementers. The mobile-telecommunication market, which is claimed to have the most SEP litigation and licensing inefficiencies, has over the years seen rapid growth, expansion, declining consumer prices, and new market entry.

Some market imperfections are necessary-but-not-sufficient conditions for regulatory intervention. Regulation might not be necessary or proportionate if its aims could be achieved with less costly instruments.

The EU’s proposed SEP Regulation appears to pursue the value-redistributive function of imposing costs on only one group (SEP owners), while accruing all benefits to non-EU (or US)-based standard implementers. It is difficult to find justification for such value redistribution from the evidence presented on the functioning of SEP licensing markets.

The proposed EU SEP Regulation applies to all standards licensed on FRAND terms. It is unclear how many standards would be caught and why all standards licensed on FRAND terms are presumed to be inefficient, requiring regulatory intervention. One early study identified 148 standards licensed on FRAND terms in a 2010 laptop. No evidence was presented that licensing inefficiencies of these standards caused harms in laptop markets.

The EU legislation would require evaluators and conciliators that need to be qualified and experienced experts in relevant fields. There are unlikely to be enough evaluators to conduct essentiality checks reliably on such a massive scale.

To make matters worse, the proposed SEP Regulation raises competition concerns, as it requires SEP owners to agree on global aggregate royalty rates. No safeguards are provided against the exchange of sensitive commercial information and possible cartelization.

There is also a risk that legislation seeking to make the standardization space more transparent, by mandating aggregate royalty-rate notifications and nonbinding expert opinions on global aggregate royalty rates, may lead to even more confusion for implementers.

Finally, the EU’s proposed SEP Regulation would have extraterritorial effects. Indeed, while the SEP Register and system of “essentiality checks” created by the regulation would apply only for patents in force in EU Member States, its system of nonbinding opinions on aggregate royalties and FRAND determination would apply worldwide, covering portfolios in other countries. Other countries—including the United States—may follow suit and introduce their own regulations on SEPs. Such regulations may be used as a strategic and protectionist tool to devaluate the royalties of innovative SEP owners. The proliferation of regulatory regimes would make SEP licensing even more costly, with unknown effects on the viability of the current system of collaborative and open standardization.

Considering the above, it would appear unwise for the United States to mimic the EU’s draft SEP regulation. In its current form, the regulation is likely to harm both U.S. and European innovators. In turn, this threatens the west’s technological leadership on a global stage and will serve the interests of jurisdictions whose economies rely heavily on implementing standard-essential technologies and that generally have weaker IP protection than either the United States or the EU.

Instead, the agencies should look for opportunities to work with their foreign counterparts to improve the proposed EU legislation (and other similar measures in other jurisdictions). Neither EU nor U.S. interests will be well-served by these sorts of regulatory endeavors, least of all if both areas enact ill-advised SEP policies. Sound policy should be focused on ensuring that the successful SEP ecosystem continues to perform as impressively as it has to date. Enacting defensive measures against the EU legislation will create a tit-for-tat dynamic that will double the obstacles faced by innovators in both the EU and the United States, allowing foreign rivals to take advantage of the situation.

II.      Regulatory Restraint

In their call for comments, the agencies ask what private entities can do to boost America’s participation in international standard-setting efforts:

What more can other entities do, such as standards development organizations, industry or consumer associations, academia, or U.S. businesses to help improve American leadership, participation in international standard setting, and/or increased participation of small to medium-sized enterprises that rely on the ability to readily license standard essential patents?[11]

While this is a good way to look at the issue (today’s standardization practices were born of spontaneous market interactions, rather than government fiat, which leaves private entities with a clearly significant role to play in this space), one should not overestimate the extent to which governments can identify inefficiencies that may afflict standard-reliant industries and nudge private parties to resolve them—e.g., by asking SDOs to curb the use of injunctions or encourage collective royalty-setting agreements.

It’s tempting for lawmakers to look at the complex SEP licensing process as a Gordian Knot to be solved through regulatory fiat. But pursuing Alexander’s solution, though expedient, would similarly leave the SEP licensing ecosystem in tatters.

Consider smartphones: Tens of thousands of patents are essential to making smartphone technology work.^[12] Some critics posit that this makes it extremely difficult to market smartphones effectively, but no evidence supports this claim, and the proliferation of smartphones suggests otherwise.[13] It is worth considering that cellphone technology marks the culmination of research efforts spanning the entire globe. The coordinated efforts of these numerous firms are not the result of government coercion, but the free play of competitive forces.

Coordination on such a vast scale is no simple task. And yet, of the vast array of options available to them, an increasing number of firms have settled on one particular paradigm to solve these coordination problems: the development of new technologies and open standards within SDOs. These organizations and their members are responsible not only for wireless cellular technologies (e.g., 3G, 4G, 5G) but also for such high-profile technologies as Wi-Fi, USB, and Blu-ray, among many others.[14]

Throughout history, economic actors have sought to reap the benefits of specialization and interoperability. This has led to the emergence of various standardization practices, ranging from de facto standards and competition for the market, to complex standard-setting procedures within SDOs.

Ultimately, because interoperability standards rely on firms being able to coordinate their behavior, standardization necessarily implies a degree of incentive compatibility. That is, parties will coordinate their behavior only if they expect that doing so will be mutually beneficial. “This mutuality of considerations has been at the heart of the voluntary FRAND bargain from the outset, given that any risks of holdup or misappropriation of information are bilateral—that is, such risks work in both directions.”[15] This implies that SDOs must design balanced internal rules that bring both patent holders and implementers to the table through mutually agreeable interoperability standards, and guarantee that they will continue to work together into the future as new technologies emerge.[16]

Establishment of SDO interoperability standards typically follows a process by which interested parties come together and identify technological problems that they might be able to solve cooperatively.^[17] SDO members include a wide range of stakeholders, including (among others): companies that manufacture products implementing the technology, companies that market services that use the standards, companies that operate networks that practice the standards, technology firms that create technologies that are included in the standards, academic institutions, and government agencies.[18]

The SDO provides information to interested parties about the standard-setting project and a forum for collaboration.[19] Members attend standard-setting meetings, vote on standardization decisions, and make technological contributions. Participation in standard setting can be subject to a substantial fee and always entails considerable time. There are policies and procedures (“bylaws”) that govern the process of adoption and standard development. Participation in SDOs is voluntary and is subject to acceptance of the terms and conditions set out in the bylaws. These aim to allow the most appropriate technology to become standardized, based on several factors. This is a democratic and consensus-based process designed to ensure that no single participant can manipulate it. Many SDOs also allow for post-adoption appeals by dissenting members. This ultimately leads to a series of technical specifications upon which implementers can build products.

Throughout this process, a critical challenge for SDOs is to ensure that their internal regulations remain “incentive compatible.” To optimize their technological output and ensure the success of their standards, SDOs must attract the right mix of both implementers and innovators. “Most succinctly, the ‘right membership’ comprises a significant portion of each class of stakeholder whose active support is needed to achieve broad adoption.”[20] They thus need to design internal procedures that strike a balance between the sometimes-diverging interests of these stakeholders.

This is no simple task. Although there are numerous ways in which these rules may favor a particular group of participants, allocating the profits of standardization is perhaps the most salient. To a first approximation, SEP holders will tend to favor internal rules that allow them to charge prices that are close to the monopoly benchmark (though not the double-marginalization one). Conversely, implementers will generally prefer policies that limit SEP holders’ returns (so long as this does not dry up the supply of inventions). However, these first-order incentives may not always hold true in the real world. Practical considerations may, for instance, urge SEP holders to accept a pricing structure that is not “profit maximizing” in the short run, but which may incentivize further cooperation or the adoption of an underlying technology.^[21]

The above has important consequences for patent and antitrust policy in SEP-reliant industries. As we have explained, collaborative standard development gives rise to complex incentives, as well as a web of heterogeneous and deliberately incomplete contracts (i.e., where the parties choose not to specify some aspects of their agreement).[22] Given this diversity, uniform and centralized policies that needlessly constrain the range of negotiation—such as a federal-enforcement presumption against injunctions—would likely lead to fewer agreements and inefficient outcomes in numerous cases, especially compared to case-by-case adjudication of F/RAND commitments under the common law of contract.[23]

In short, “standards organizations and market participants are better than regulators at balancing the interests of patent holders and implementers.”[24] Interfering with the emergent norms of the standard-development industry thus risks undermining innovators’ expectations of a reasonable return on their investments:

Each of the innovative companies that agrees to be an SSO participant does so with the understanding of the investments they have made in research, development, and participation, as well as the risks that their innovations may not be selected for incorporation in the standard. They bear these investments and risk with the further understanding that they will receive adequate and fair remuneration as part of the FRAND commitment they have made to the SSO.

Unfortunately, the actions of the courts and the proposals by commentators are greatly undermining the value and benefits of SSO participation that are expected….[25]

III.    The Importance of Injunctions

The agencies’ call for comments appears concerned that current standardization practices may be hindering U.S. innovation and the creation of startups in the SEP space:

Are current fair, reasonable, and non-discriminatory (FRAND) licensing practices adequate to sustain U.S. innovation and global competitiveness? Are there other international models which would better serve U.S. innovation in the future?

Are there specific U.S. intellectual property laws or policies that inhibit participation in standards development?

Are there specific U.S. intellectual property laws or policies that inhibit growth of SMEs that rely on licensing and implementing standards? [26]

While they are not mentioned explicitly in the agencies’ call for comments, the role of injunctions sought against implementers by SEP holders looms large over the above questions. The use of injunctions is arguably one of the most contentious—and widely misunderstood—topics in SEP policy debates. While often portrayed as a means for inventors to extract unreasonable royalties from helpless implementors injunctions are, in fact, a critical legal tool that encourages all parties in the standardization space to come to the negotiation table. In fact, even the EU’s draft regulation on SEPs—which in many other respects reduces the protections afforded to inventors—implicitly recognizes the crucial role that injunctions play, by ensuring that the various proposed SEP transparency and arbitration procedures do not undermine parties’ ability to obtain an injunction:

The obligation to initiate FRAND determination should not be detrimental to the effective protection of the parties’ rights. In that respect, the party that commits to comply with the outcome of the FRAND determination while the other party fails to do so should be entitled to initiate proceedings before the competent national court pending the FRAND determination. In addition, either party should be able to request a provisional injunction of a financial nature before the competent court.[27]

A.   The Fundamental Value of Injunctions

Historically, one of the most important features of property rights in general, and patents in particular, is that they provide owners with the power to exclude unauthorized use by third parties and thus enable them to negotiate over the terms on which instances of use or sale will be authorized.^[28] While the ability to exclude is important in creating the incentive to innovate, it is equally—and perhaps more—important in facilitating the licensing of inventions.^[29]

There are many reasons that someone may invent a new product or process. But if they are to be optimally encouraged to distribute that product and thus generate the associated social welfare, it is crucial that they retain the ability to engage supply chains to commercialize the invention fully.^[30] “[T]he patent system encourages and enables not just invention but also innovation by providing the basic, enforceable property rights that facilitate (theoretically) efficient organizations of economic resources and the negotiations necessary to coordinate production among them.”[31] If a patent holder believes that the path to commercialization and remuneration is hindered by infringers, she will have less incentive to invest fully in the commercialization process (or in the innovation in the first place).

Removing the injunction option… not only changes the bargaining range (and makes infringement a valid business option), but, by extension, it lowers the expected returns of investing in the creation and commercialization of patents, in the first place…. With a no-injunction presumption…, as long as the expected cost of litigation is less than the expected gain from infringing without paying any royalties, potential licensees will always have an incentive to pursue this strategy. The net result is a shift in bargaining power so that, even when license agreements are struck, royalty rates are lower than they would otherwise be, as well as an increased likelihood of infringement.[32]

Because infringement affects both the initial incentive to innovate as well as the complex process of commercialization, courts have historically granted injunctions against those who have used a patent without proper authorization.

B.   Damages Alone Are Often Insufficient

Injunctions are almost certainly the most powerful means to enforce property rights and remedy breaches. Nonetheless, courts may sometimes award damages, either in addition to or as an alternative to awarding an injunction.^[33] It is often difficult to establish the appropriate size of an award of damages, however, when intangible property—such as invention and innovation, in the case of patents—is the core property being protected.

In this respect, a key feature of patents is that they possess uncertain value ex ante. The value of a particular invention or discovery cannot be known until it is either integrated into the end-product that will be distributed to consumers, or actually used by consumers.[34] This massive upfront uncertainty creates the need for technology designers to carefully structure their investments such that the risk/reward ratio remains sufficiently low. This, in turn, means ensuring that their inventions’ commercialization can reasonably be expected to generate sufficient profits.

Commercializing highly complex innovations, such as pharmaceuticals and advanced technologies, requires a large degree of risk taking and capital investment, as well as massive foregone opportunities. As such, it will often be difficult, or even impossible, to adequately calculate appropriate monetary damages for the unauthorized use of a patent, even if the patent’s ex post value is knowable. Put differently, the inability to bargain effectively for royalties post-standardization may “deter investment… and ultimately harm consumers.”[35]

While it is necessary to establish damages for violations after the fact, it will nearly always be appropriate to award injunctions to deter ongoing violations. This would further allow the property owner to do their own value calculations, based on their investments, sunk costs, and—critically—lost opportunities that were foregone in order to realize the particular invention. “[A] property rule is superior to a liability rule when ‘the court lacks information about both damages and benefits.’ Without accurate information, the damages may be set below the actual level of harm, encouraging the ‘injurer’ (or infringer) to engage in an excessive level of activity—in our case, increased infringement.”[36]

C.   Injunctions Encourage Efficient Licensing Negotiations

In addition to the concerns outlined in the previous section, it is worth noting that curbs on injunctions pertaining to SEPs would make inventors bear the risk of opportunistic behavior, thus enabling  firms to opt out of commercial negotiations and wait for potential litigation. In turn, this would tilt the bargaining scale in their favor in subsequent royalty negotiations undertaken in the shadow of prior court proceedings.[37]

The U.S. Supreme Court’s 2006 decision in eBay v. MercExchange offers a case in point. The court rejected the “general rule” that a prevailing patentee is entitled to an injunction.[38] In the aftermath of the decision, courts refused to grant injunctions in considerably more cases.[39]

Nearly two decades later, however, questions remain regarding eBay’s effect on patent licensing, negotiation, and litigation.[40] In particular, it is likely that eBay systematically distorted the relative bargaining positions in SEP licensing in favor of implementers, at the expense of patent holders. One post-eBay assessment argues that limiting injunctions to prevent holdup results in more “false positives”—where patent holders with no designs of patent holdup are nonetheless denied injunctive relief—than it does deterrence of actual holdups.[41] The result is a reduction in the cost of willful infringement and “under-compensation” for innovation.[42]

One of the important features of injunctions that critics miss is that they are not solely a tool for simple exclusion from property, but a tool that promotes efficient bargaining.[43] If a property holder ultimately has the right to exclude infringers, there is relatively more weight placed on the importance of initial bargaining for licenses. “It is the very threat of the injunction right—and its associated high transaction costs—that brings the parties to the negotiating table and motivates them to draw upon the full scope of their knowledge and creativity in forming contractual and institutional solutions to the perceived holdup problem.”[44]

Post-eBay, “efficient infringement” becomes a viable choice for firms seeking to maximize profits. Thus, implementing firms seeking to pay as little as possible for use of an invention have incentive to disregard the bargaining process with a patent holder altogether. The relative decline in the importance of injunctions narrows the bargaining range. The narrower range of prices that an implementing firm will offer means that, even where it does bargain, agreement will be less likely. Where rightsholders can be reasonably expected to enforce their patent rights, by contrast, the bargaining range is expanded and agreement is more likely, because the initial cost of negotiating for a license is relatively less than always (or usually) opting for “efficient infringement”; that is, infringement becomes less efficient.

The ultimate tension is not between seeking damages or an injunction, but between whether a firm opts to negotiate or to litigate, while facing the risk of some combination of damages and injunction on the back end.

This reality is particularly important in the context of SDOs, where implementers and innovators are in a constant dance both to maximize their own profits as well as to facilitate the product of an incomplete, joint agreement that binds each party. “The seminal example of intentional contractual incompleteness is the F/RAND commitment common in many [SDO’s] IPR policies.”[45] Permitting one party, through weakened legal doctrine, to circumvent or artificially constrain the bargaining process inappropriately imbalances the careful commercial relationships that should otherwise exist.

In the SEP context, furthermore, it is rarely mentioned that “an implementer’s decision to reject a certifiably F/RAND license and continue to infringe is contrary to the spirit of the F/RAND framework as well.”^[46]

Moreover, it is not typically the case that a negotiation process would end with an injunction and a refusal to license, as critics sometimes allege. Rather, the threat of an injunction is important in hastening an infringing implementer to the table and ensuring that protracted litigation to determine the appropriate royalty (which is how such disputes do actually end) is costly not only to the patentee, but also to the infringer. As James Ratliff and Daniel Rubinfeld explain:

[T]he existence of that threat does not lead to holdup as feared by those who propose that a RAND pledge implies (or should embody) a waiver of seeking injunctive relief. If RAND terms are reached by negotiation, the negotiation is not conducted in the shadow of an injunctive threat but rather in the shadow of knowledge that the court will impose a set of terms if the parties do not reach agreement themselves. The crucial element of this model that substantially diminishes the likelihood that the injunctive threat will have real bite against an implementer willing to license on RAND terms is the assumption that an SEP owner maintains its obligation to offer a RAND license even if its initial offer is challenged by the implementer and, further, even if the court agrees with the SEP owner that its initial offer was indeed RAND. Thus any implementer that is willing to license on court-certified RAND terms can avoid an injunction by accepting those RAND terms without eschewing any of its challenges to the RAND-ness of the SEP owner’s earlier offers.[47]

Ultimately, this means that an implementer that accepts nominally F/RAND terms need not be an actual “willing licensee,” but instead can gain that designation as a matter of law without ever accepting a royalty rate within the true bargaining range that includes the licensor’s valid injunction threat. “[B]y stripping the SEP holder’s right to injunctive relief, [a no-injunction rule] may enable a potential licensee to delay good faith negotiation of a F/RAND license and the patent holder could be forced to accept less than fair market value for the use of the patent…. Undermining this bargaining outcome using antitrust rules runs a significant risk of doing more harm than good.”[48]

For the purposes of this proceeding, the lesson is clear: U.S. policy needs to return to a neutral position in which both parties in a F/RAND negotiation are encouraged to reach mutually agreeable terms in arm’s length licensing transactions. The effects of eBay and its progeny have distorted that bargaining process. Here, the agencies have an important role to play in pressing the need for this change.

IV.    Increased Transparency Is No Free Lunch

The agencies’ call for comments asks whether increased transparency requirements in the SEP space could make SEP licensing more efficient:

What can the Department of Commerce do to mitigate emergence or facilitate the resolution of FRAND licensing disputes? Can requiring further transparency concerning patent ownership make standard essential patent (SEP) licensing more efficient? What are other impediments to reaching a FRAND license that the Department of Commerce could address through policy or regulation?[49]

But while fostering transparency may appear to be a win-win proposition for all parties in the standardization space, the reality is far more complex. In many instances, inventors are already required to disclose their standard essential patents—and these requirements have ambiguous effects.[50] Given this, demands for further transparency would almost certainly entail some form of government intervention, such as the creation of SEP registers and government-run essentiality checks, which seek to verify whether the patents that firms declare as standard-essential are truly so.

Unfortunately, these attempts to make SEP-reliant industries more transparent are anything but costless. The EU’s draft SEP regulation offers a case in point. The regulation would create a system of government-run essentiality checks and nonbinding royalty arbitrations that seek to make the process easier for implementers. But as ICLE scholars have written, this scheme will prove extremely difficult and costly to operate in practice.[51] Much the same would be true of attempts to introduce similar measures in the United States.

The proposed EU regulation would rely on qualified experts to work as evaluators and conciliators. Evaluators will need specialized knowledge of the particular technological area in which they will conduct essentiality checks. The European Commission estimates that there are about 1,500 experts (650 patent attorneys and 800 patent examiners) qualified to do essentiality checks in the EU.[52]

The sheer magnitude of the task, however, will require many more evaluators and it is very doubtful that the optimal number of potential qualified experts are even available to join this process. For certain, special arrangements would need to be made with patent offices to grant patent examiners leave to conduct essentiality checks. Each year, evaluators would need to test a random sample of up to 100 SEPs if requested by each SEP owner or an implementer per standard. Thus, the amount of work may exponentially increase depending on how many standards are caught by the regulation.

If 148 FRAND-licensed standards per laptop are to serve as a rough proxy, then we might expect more than 100-200 standards to be checked for essentiality every year. In addition, if SEP owners and implementers regularly use the possibility of testing up to 100 SEPs per standard and per SEP owner, the sheer magnitude of work may exceed the capacity of patent attorneys. Patent attorneys may find it challenging to regularly engage in such high volumes of essentiality checks while also serving other clients. And why should they do it at all unless the rate of pay is at least what they could earn in a patent law firm? To be blunt, the work would not be as much fun as acting for real clients, so the pay would probably have to be even higher to attract applicants.

Consequently, it is very unlikely that the capability even exists to annually perform a large number of essentiality checks of registered SEPs. If the requirements to become an evaluator were relaxed to address this workload, this would cast doubt on the reliability of the whole system. There is no point in building a battleship unless you are sure you can get a competent crew.

Additionally, the patent attorneys most likely to be familiar with these technologies may well also find themselves with conflicts of interest. They will probably have worked for some SEP owners or implementers. Elaborate rules to avoid such conflicts would need to be implemented to prevent patent attorneys who were, or still are, engaged with certain clients from becoming evaluators of those clients’ registered SEPs. The conflicts problem would, of course, apply not just to individual attorneys but to their entire firms.

Conciliators would also need to be experts in the field. They might come from the ranks of retired judges, seasoned former company officials, or experienced lawyers. Conflict-of-interest provisions would also be needed to ensure their independence and impartiality in mandatory FRAND determinations.  But the job would, again, have to be sufficiently attractive, both in remuneration and in work content and culture. The Commission has made no investigation as to whether a sufficiently large pool of credible individuals could be found to make the system work.

Of course, there are well-established voluntary systems of conciliators and mediators, some of which are used now to help resolve FRAND disputes. But the proposal adds the idea of compulsory mediation or conciliation. There is scant evidence that either system works in other commercial disputes around the world, and it is unclear why it should be assumed to work here.

In short, it is doubtful that a government-operated scheme of essentiality checks and SEP-royalty arbitrations could reach satisfactory outcomes, as the expertise to do so is lacking and attracting potentially thousands of professionals from the private sector would be too costly. The result is that any government scheme along these lines is unlikely to have the necessary staffing to conduct its mission to the requisite standard. It would thus risk doing more harm than good.

V.      SEP Rights and China’s ‘Cyber Great Power’ Ambitions

In their call for comments, the agencies express a desire to protect the United States’ leading position in the field of standard development and implementation:

Are there steps that the Department of Commerce can take regarding intellectual property rights policy that will help advance U.S. leadership in standards development and implementation for critical and emerging technologies?[53]

The agencies essentially ask what active steps they could take to preserve the United States’ leading position. This, however, ignores the arguably more important question: What steps should the United States avoid taking? As we explain below, U.S. agencies should be particularly careful not to weaken intellectual-property protection in ways that may, ultimately, favor firms in other jurisdictions, such as China.

Observers often regard intellectual property as merely protecting original creations and inventions, thus boosting investments. But while IP certainly does this, it is important to look beyond this narrow framing. Indeed, by protecting these creations, intellectual-property protection—particularly that of patents—produces beneficial second-order effects in several important policy areas.

Consequently, weakening patent protection could have detrimental ramifications that are routinely overlooked by policymakers. This includes giving a leg up to jurisdictions that are heavily geared toward manufacturing, rather than  R&D, and specifically to  China (with knock-on effects for ongoing political tensions between these two superpowers).

As the USPTO has observed:

Innovation and creative endeavors are indispensable elements that drive economic growth and sustain the competitive edge of the U.S. economy. The last century recorded unprecedented improvements in the health, economic well-being, and overall quality of life for the entire U.S. population. As the world leader in innovation, U.S. companies have relied on intellectual property (IP) as one of the leading tools with which such advances were promoted and realized.[54]

The United States is a world leader in the production and commercialization of IP, and naturally seeks to retain that comparative advantage.[55] IP and its legal protections will become increasingly important if the United States is to maintain its prominence, especially when dealing with international jurisdictions, like China, that don’t offer similar levels of legal protection.[56] By making it harder for patent holders to obtain injunctions, licensees and implementers gain the advantage in the short term, because they are able to use patented technology without having to engage in negotiations to pay the full market price. In the case of many SEPs—particularly those in the telecommunications sector—a great many patent holders are U.S.-based, while the lion’s share of implementers are Chinese. Potential anti-injunction policies may thus amount to a subsidy to Chinese infringers of western technology.

At the same time, China routinely undermines western intellectual-property protections through its industrial policy. The government’s stated goal is to promote “fair and reasonable” international rules, but it is clear that China stretches its power over intellectual property around the world by granting “anti-suit injunctions” on behalf of Chinese smartphone makers, designed to curtail enforcement of foreign companies’ patent rights.[57]

In several recent cases, Chinese courts have claimed jurisdiction over F/RAND issues.[58] In Oppo v. Sharp, the Supreme People’s Court of China determined that Chinese courts can set the global terms of what is a fair and reasonable price for a license,[59] even if that award would be considerably lower than in other jurisdictions. This decision follows Huawei v. Conversant, in which a Chinese court for the first time claimed the ability to issue an anti-suit injunction against the Chinese company.[60]

All of this is part of the Chinese government’s larger approach to industrial policy, which seeks to expand Chinese power in international trade negotiations and in global standards bodies.[61] As one Chinese Communist Party official put it: “Standards are the commanding heights, the right to speak, and the right to control. Therefore, the one who obtains the standards gains the world.”[62] Chinese President Xi Jinping frequently (but only domestically) references China’s “cyber great power” ambitions: “We must accelerate the promotion of China’s international discourse power and rule-making power in cyberspace and make unremitting efforts towards the goal of building a cyber great power.”[63] Chinese leaders are intentionally pursuing a two-track strategy of taking over standards bodies and focusing on building platforms to create path dependencies that cause others to rely on Chinese technology.[64] As a Hinrich Foundation Report notes:

Trade and technical standards are inherently interrelated. They are mutually reinforcing. But Beijing treats standard setting, and standards organizations, as competitive domains. This approach risks distorting global trade. Beijing does not support a neutral architecture where iterative negotiating strives for technical interoperability. Instead, Beijing promotes an architecture that bolsters and cements Chinese competitiveness. Due to China’s size and centralization, the consequences of this approach will reverberate across the international system. Given the nature of emerging technology and standards, the consequences will endure.[65]

Insufficient protections for intellectual property will hasten China’s objective of dominating collaborative standard development in the medium- to long-term.[66] U.S. entrepreneurs are able to engage in the types of research and development that drive innovation because they can monetize those innovations. Reducing the returns for patents that eventually become standards will lead to less investment in those technologies. It will also harm the competitive position of American companies that refrain from collaborating because the benefits don’t outweigh the costs, including “missing the opportunity to steer a standard in the manner most compatible with a company’s product offerings, falling behind competitors, or failing to head off broad adoption of a second standard….”[67]

Simultaneously, this will engender a switch to greater reliance on proprietary, closed standards rather than collaborative, open standards. Proprietary standards (and competition among those standards) are sometimes the most efficient outcome: for instance, when the costs of interoperability outweigh the benefits. The same cannot be said, however, for government policies that effectively coerce firms into adopting proprietary standards by raising the relative costs of the collaborative standard-development process. In other words, there are social costs when firms are artificially prevented from taking part in collaborative standard setting and forced instead to opt for proprietary standards.

Yet this is precisely what will happen to U.S. firms if IP rights are not sufficiently enforceable. Indeed, as explained above, collaborative standardization is an important driver of growth.[68] It is crucial that governments do not needlessly undermine these benefits by preventing American firms from competing effectively in these international markets.

These harmful consequences are magnified in the context of the global technology landscape, and in light of China’s strategic effort to shape international technology standards.[69] With U.S. firms systematically deterred from participating in the development of open technology standards, Chinese companies, directed by their government authorities, will gain significant control of the technologies that will underpin tomorrow’s digital goods and services. The consequences are potentially catastrophic:

The effect of [China’s] approach goes far beyond competitive commercial advantage. The export of Chinese surveillance and censorship technology provides authoritarian governments with new tools of repression. Governments that seek to control their citizens’ access to the internet are supportive of Beijing’s “cyber sovereignty” paradigm, which can lead to a balkanized internet riddled with incompatibilities that impede international commerce and slow technological innovation. And when cyber sovereignty is paired with Beijing’s push to redefine human rights as the “collective” rights of society as defined by the state, authoritarian governments gain a shield of impunity for violations of universal norms.[70]

With Chinese authorities joining standardization bodies and increasingly claiming jurisdiction over F/RAND disputes, there should be careful reevaluation of the ways weakened IP protection would further hamper the U.S. position as  a leader in intellectual property and innovation.

To return to the framing question, yes, there are steps the agencies could take to secure and promote U.S. leadership in intellectual-property-intensive industries. The first step, as noted throughout this comment, is to refrain from promoting policies that unnecessarily imbalance the negotiation process between innovators and implementers. The second step is twofold. First, work with trustworthy partners, like the EU, to make sure that U.S. Allies’ IP policies are in alignment with and are geared  toward promoting neutral standards that allow tech industries to thrive. The second part is to advocate for trade policies that dissuade countries like China from using their domestic courts and regulatory agencies as protectionist entities designed simply to advance China’s national interests.

VI.    Competition Concerns with Aggregate Royalties

In the call for comments, the agencies ask:

Do policy solutions that would require SEP holders to agree collectively on rates or have parties rely on joint negotiation to reach FRAND license agreements with SEP holders create legal risks? Are there other concerns with these solutions?[71]

A host of competition concerns are implicated in this question, in that it requires SEP owners to negotiate and ultimately agree on aggregate royalty rates for standards.  This may require SEP owners to exchange sensitive commercial information relevant to establishing the value that devices derive from using the standardized technology. Competition-sensitive data could include projected revenues on a per-unit basis following the incorporation of connectivity in the end products, the number of end products sold on the market, actual and forecast sales, and price projections.[72] The competitive dangers inherent in this process are more serious for those vertically integrated SEP owners, who simultaneously hold SEPs and manufacture standard-implementing products. They would effectively agree to set the costs (royalties) for their inputs and exchange data about their downstream sales.

Jointly negotiated rates could therefore potentially run afoul of antitrust laws that prohibit companies from engaging in price-fixing and collusion. Requirements to jointly negotiate aggregate royalty rates should thus be accompanied by safeguards and guidance that ensure such negotiations comply with antitrust law. An example would be royalty-rate negotiations in patent pools, where pool administrators take a mediatory role, collecting and protecting confidential information from pool members.[73]

It is also unclear whether these joint royalty negotiations would be of much use to either inventors or implementers. For example, the EU has proposed introducing an aggregate notification regulation along these lines. The regulation appears to allow multiple groups of SEP owners to jointly notify their views concerning the appropriate royalties for a given technology. This could add even more confusion for standard implementers. For example, some SEP owners could announce an aggregate rate of $10 per product, another 5% of the end-product price, while a third group would prefer a lower $1 per-product rate.

Moreover, it is unclear how joint aggregate royalty-rate notifications would change the existing practice of unilateral announcement of licensing terms. Many SEP owners already publicly announce their royalty programs in advance. To be on the safe side, SEP owners may simply notify their maximum preference, knowing that negotiations would lead to different prices depending on the unique details of various licensees. As a result, aggregate royalty rates may not produce meaningful data points.

Nonbinding expert opinions on global aggregate royalty rates could also add to the confusion. Implementers would likely initiate the process, which would then proceed in parallel with SEP owners’ joint notifications of aggregate rates. All these differing and possibly conflicting estimates might lead to even greater uncertainty. Moreover, if those providing nonbinding opinions are not universally regarded as “experts,” the parties are unlikely to respect such opinions.

Aggregate royalty notifications and nonbinding opinions might be used in the top-down method for FRAND-royalty determinations. A top-down method provides that the SEP owner should receive a proportional share of a standard’s total aggregate royalty. It requires establishing a cumulative royalty for a standard and then calculating the share of the total royalty for an individual SEP owner. This may be the reason for having aggregate royalty-rate notifications and opinions. At the same time, essentiality checks would still be needed to filter out which patents are truly essential, and to assess each individual SEP owner’s share.

We caution strongly against relying too heavily on the top-down approach for FRAND-royalty determinations. It is not used in commercial-licensing negotiations, and courts have frequently rejected its application. Industry practice is to use comparable licensing agreements. The top-down approach was applied in Unwired Planet v Huawei only as a cross-check for the rates derived from comparable agreements.[74] TCL v Ericsson relied on this method, but was vacated on appeal.[75] The most recent Interdigital v Lenovo judgment considered and rejected its use, finding “no value in Interdigital’s Top-Down cross-check in any of its guises.”[76] Moreover, the top-down approach, as currently applied, relies solely on patent counting. It fails to consider that not every patent is of equal value, nor that some patents may be invalid or not infringed by a specific device.

In short, there are important legal and practical obstacles to the joint negotiation of aggregate royalty rates. Legal mandates to conduct such negotiations would thus be of dubious added value to players in standard-reliant industries.

[1] U.S. Patent and Trademark Office, Joint ITA-NIST-USPTO Collaboration Initiative Regarding Standards, Federal Register (Sep. 27, 2023), https://www.federalregister.gov/documents/2023/09/27/2023-20919/joint-ita-nist-uspto-collaboration-initiative-regarding-standards; U.S. Patent and Trademark Office, Joint ITA–NIST–USPTO Collaboration Initiative Regarding Standards; Notice of Public Listening Session and Request for Comments, Federal Register (Sep. 11, 2023), available at https://www.govinfo.gov/content/pkg/FR-2023-09-11/pdf/2023-19667.pdf (“Call for Comments”).

[2] European Commission, Explanatory Memorandum for Proposal for a Regulation of the European Parliament and of the Council on Standard Essential Patents and Amending Regulation (EU) 2017/1001, COM (2023) 232 Final (“Explanatory Memorandum”).

[3] See, e.g., Dirk Auer & Julian Morris, Governing the Patent Commons, 38 Cardozo Arts & Ent. L.J. 294 (2020).

[4] See, e.g., Alexander Galetovic, Stephen Haber & Ross Levine, An Empirical Examination of Patent Holdup, 11 J. Competition L. & Econ. 549 (2015). This is in keeping with general observations about the dynamic nature of intellectual property protections. See, e.g., Ronald A. Cass & Keith N. Hylton, Laws of Creation: Property Rights in the World of Ideas 42-44 (2013).

[5] Oscar Borgogno & Giuseppe Colangelo, Disentangling the FRAND Conundrum, DEEP-IN Research Paper (Dec. 5, 2019) at 5, available at https://ssrn.com/abstract=3498995.

[6] Richard A. Epstein & Kayvan B. Noroozi, Why Incentives for “Patent Holdout” Threaten to Dismantle FRAND, and Why It Matters, 32 Berkeley Tech. L.J. 1381, 1411 (2017).

[7] Borgogno & Colangelo, supra note 5, at 5.

[8] Call for Comments, supra note 1, Questions 1 and 2.

[9] Proposal for a Regulation of the European Parliament and of the Council on Standard Essential Patents and Amending Regulation (EU) 2017/1001, COM (2023) 232 Final (“Draft SEP Regulation”).

[10] Robin Jacob & Igor Nikolic, ICLE Comments Regarding the Draft Regulation on Standard Essential Patents (Jul. 28, 2023), available at https://laweconcenter.org/wp-content/uploads/2023/07/ICLE-Comments-to-the-SEP-Regulation.pdf.

[11] Call for Comments, supra note 1, Question 3.

[12] See, e.g., Jorge Padilla, John Davies, & Aleksandra Boutin, Economic Impact of Technology Standards: The Past and the Road Ahead (2017), available at https://www.compasslexecon.com/wp-content/uploads/2018/04/CL_Economic_Impact_of_Technology_Standards_Report_FINAL.pdf (Section 3 has an in-depth discussion of the adoption of standards and the benefits to the growth of mobile technology); iRunway, Patent & Landscape Analysis of 4G-LTE Technology 9-12 (2012), https://www.i-runway.com/images/pdf/iRunway%20-%20Patent%20&%20Landscape%20Analysis%20of%204G-LTE.pdf.

[13] See, e.g., Galetovic, et al., supra note 4; Keith Mallinson, Don’t Fix What Isn’t Broken: The Extraordinary Record of Innovation and Success in the Cellular Industry under Existing Licensing Practices, 23 Geo. Mason L. Rev. 967 (2016); Damien Geradin, Anne Layne-Farrar, & Jorge Padilla, The Complements Problem within Standard Setting: Assessing the Evidence on Royalty Stacking, 14 B.U. J. Sci. & Tech. L.144 (2008).

[14] Auer & Morris, supra note 3, at 5.

[15] Epstein & Noroozi, supra note 6, at 1394.

[16] See, e.g., Daniel F. Spulber, Standard Setting Organisations and Standard Essential Patents: Voting and Markets, 129 Econ. J. 1477, 1502-03 (2018) (“The interaction between inventors and adopters helps explain the variation of decision rules among SSOs, ranging from majority rule to consensus requirements…. Technology standards will be efficient when SSO decision making reflects the countervailing effects of voting power and market power.”).

[17] See Kirti Gupta, How SSOs Work: Unpacking the Mobile Industry’s 3GPP Standards, in The Cambridge Handbook of Technical Standardization Law: Competition, Antitrust, and Patents (Jorge L. Contreras ed., 2017).

[18] See Kristen Jakobsen Osenga, Ignorance Over Innovation: Why Misunderstanding Standard Setting Organizations Will Hinder Technological Progress, 56 U. Louisville L. Rev. 159, 178 (2018); Andrew Updegrove, Value Propositions, Roles and Strategies: Participating in a SSO, in The Essential Guide to Standards, https://www.consortiuminfo.org/guide (last visited Jan. 23, 2022).

[19] Adapted from Auer & Morris, supra note 3, at 18-19.

[20] Andrew Updegrove, Business Considerations: Forming and Managing a SSO, in The Essential Guide to Standards, https://www.consortiuminfo.org/guide/forming-managing-a-sso/business-considerations (last visited Nov. 6, 2023).

[21] See, e.g., Jonathan M. Barnett, The Host’s Dilemma: Strategic Forfeiture in Platform Markets for Informational Goods, 124 Harv. L. Rev. 1861, 1883 (2010) (showing that firms routinely forfeit their intellectual assets in order to boost the growth of the platform they operate).

[22] See Joanna Tsai & Joshua D. Wright, Standard Setting, Intellectual Property Rights, and the Role of Antitrust in Regulating Incomplete Contracts, 80 Antitrust L.J. 157, 159 (2015) (“SSOs [standard-setting organizations] and their IPR policies appear to be responsive to changes in perceived patent holdup risks and other factors. We find the SSOs’ responses to these changes are varied, and that contractual incompleteness and ambiguity persist across SSOs and over time, despite many revisions and improvements to IPR policies. We interpret the evidence as consistent with a competitive contracting process and with the view that contractual incompleteness is an intended and efficient feature of SSO contracts.”) (emphasis added).

[23] See, e.g., Daniel F. Spulber, Licensing Standard Essential Patents with FRAND Commitments: Preparing for 5G Mobile Telecommunications, 18 Co. Tech. L.J. 79, 147 (2020) (“Adjudication of SEP disputes guided by common law principles and comparable licenses complements SSO FRAND commitments and market negotiation of SEP licenses. Adjudication based on common law and comparable licenses provides general rules for the resolution of SEP disputes that does not restrict SSO IP policies and or interfere with consensus decision making by SSOs. Such adjudication also does not interfere with efficient market negotiation of SEP licenses.”).

[24] Id. at 148.

[25] Osenga, supra note 19, at 213-14.

[26] Call for Comments, supra note 1, Questions 4, 5, 6.

[27] Draft SEP Regulation, preamble at (35).

[28] Richard A. Epstein, The Clear View of The Cathedral: The Dominance of Property Rules, 106 Yale L.J. 2091, 2091 (1996) (“Property rights are, in this sense, made absolute because the ownership of some asset confers sole and exclusive power on a given individual to determine whether to retain or part with an asset on whatever terms he sees fit.”)

[29] See generally Edmund W. Kitch, The Nature and Function of the Patent System, 20 J.L. & Econ. 265 (1977); F. Scott Kieff, Property Rights and Property Rules for Commercializing Inventions, 85 Minn. L. Rev. 697 (2001).

[30] See, e.g., Barnett, supra note 22, at 856 (“Strong patents provide firms with opportunities to disaggregate supply chains through contract-based relationships, which in turn give rise to trading markets in intellectual resources, whereas weak patents foreclose those options.”).

[31] Dirk Auer, Geoffrey A. Manne, Julian Morris, & Kristian Stout, The Deterioration of Appropriate Remedies in Patent Disputes, 21 Federalist Soc’y Rev. 158, 160 (2020).

[32] Id. at 163.

[33] See, e.g., Doris Johnson Hines & J. Preston Long, The Continuing (R)evolution of Injunctive Relief in the District Courts and the International Trade Commission, IP Litigator (Jan./Feb. 2013) (citing Tracy Lee Sloan, The 1988 Trade Act and Intellectual Property Cases Before the International Trade Commission, 30 Santa Clara L. Rev. 293, 302 (1990) (“Out of 221 intellectual property cases between 1974 and 1987, the ITC found that only five failed to establish sufficient injury… for injunctive-type relief.”)), available at https://www.finnegan.com/en/insights/articles/the-continuing-r-evolution-of-injunctive-relief-in-the-district.html.

[34] And even then, the specific contribution of a particular patent to ultimate consumer value will remain uncertain. See Robert P. Merges, Of Property Rules, Coase, and Intellectual Property, 94 Colum. L. Rev. 2655, 2659 (1994) (“The problems with [clearly defining harms/benefits] in the IPR field result from the abstract quality of the benefits conferred by prior works and the cumulative, interdependent nature of works covered by IPRs. Valuation, then, is at least as great a problem as detection.”)

[35] See Richard Epstein, F. Scott Kieff, & Daniel Spulber, The FTC, IP, and SSOs: Government Hold-Up Replacing Private Coordination, 8 J. Competition L. & Econ. 1 (2012) at 21, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1907450 (“The simple reality is that before a standard is set, it just is not clear whether a patent might become more or less valuable. Some upward pressure on value may be created later to the extent that the patent is important to a standard that is important to the market. In addition, some downward pressure may be caused by a later RAND commitment or some other factor, such as repeat play. The FTC seems to want to give manufacturers all of the benefits of both of these dynamic effects by in effect giving the manufacturer the free option of picking different focal points for elements of the damages calculations. The patentee is forced to surrender all of the benefit of the upward pressure while the manufacturer is allowed to get all of the benefit of the downward pressure.”).

[36] Merges, supra note 38, at 2666-67 (quoting A. Mitchell Polinsky, Resolving Nuisance Disputes: The Simple Economics of Injunctive and Damage Remedies, 32 Stan. L. Rev. 1075, 1092 (1980)).

[37] See Auer, et al., supra note 35, at 163 (“It also establishes this lower royalty rate as the ‘customary’ rate, which ensures that subsequent royalty negotiations, particularly in the standard-setting context, are artificially constrained.”).

[38] eBay Inc. v. MercExchange, LLC, 547 U.S. 388 (2006).

[39] See Benjamin Petersen, Injunctive Relief in the Post-eBay World, 23 Berkeley Tech. L.J. 193, 196 (2008), (“In the two years after the Supreme Court’s ruling in eBay, there were thirty-three district court decisions that interpreted eBay when determining whether to grant injunctive relief to a patent holder. Of these decisions, twenty-four have granted permanent injunctions and ten have denied injunctions.”). See also Bernard H. Chao, After eBay, Inc. v. MercExchange: The Changing Landscape for Patent Remedies, 9 Minn. J.L. Sci. & Tech. 543, 572 (2008) (“For the first time, courts are not granting permanent injunctions to many successful patent plaintiffs.”); Robin M. Davis, Failed Attempts to Dwarf the Patent Trolls: Permanent Injunctions in Patent Infringement Cases Under the Proposed Patent Reform Act of 2005 and eBay v. MercExchange, 17 Cornell J.L. & Pub. Pol’y 431, 444 (2008) (“However, the first few district courts deciding patent cases following that decision granted injunctions to patent owners in the majority of cases, at a rate of approximately two-to-one.”).

[40] See generally Epstein & Noroozi, supra note 6, at 1406-08.

[41] Vincenzo Denicolò, Damien Geradin, Anne Layne-Farrar & A. Jorge Padilla, Revisiting Injunctive Relief: Interpreting eBay in High-Tech Industries with Non-Practicing Patent Holders, 4 J. Comp. L. & Econ. 571 (2008).

[42] Id. at 608. See also Vincenzo Denicolò, Do Patents Over-Compensate Innovators?, 22 Econ. Pol’y 681 (2007) (noting that, with respect to patents in general, “a preponderance of what evidence is currently available points against the over-reward hypothesis”).

[43] See, e.g., Mark Schankerman & Suzanne Scotchmer, Damages and Injunctions in Protecting Intellectual Property, 32 RAND J. Econ. 201 (2001).

[44] Epstein & Noroozi, supra note 6, at 1408.

[45] Tsai & Wright, supra note 23, at 163.

^[46] James Ratliff & Daniel L. Rubinfeld, The Use and Threat of Injunctions in the RAND Context, 9 J. Competition L. & Econ. 14 (2013).

^[47] Ratliff & Rubinfeld, supra note 50, at 7 (emphasis added).

[48] Tsai & Wright, supra note 23, at 182.

[49] Call for Comments, supra note 1, Question 9.

[50] See, e.g., Rudi Bekkers, Christian Catalini, Arianna Martinelli, Cesare Righi, and Timothy Simcoe. Disclosure Rules and Declared Essential Patents, 52 Research Policy, 104618, 3 (2023) (“Thus, allowing blanket disclosure can be efficient if the main purpose of a disclosure policy is to reassure prospective implementers that a license will be available. On the other hand, blanket disclosure shifts search costs from the patent holder (who presumably has a comparative advantage at finding its own essential patents) onto other interested parties, such as prospective licensees who wish to evaluate the scope and value of a firm’s dSEPs; other SSO participants seeking to make explicit cost-benefit comparisons of alternative technologies before committing to a standard; and regulators or courts that might use information about relevant dSEPs to determine reasonable royalties.”).

[51] See Jacob & Nikolic, supra note 10.

[52] See European Commission, Impact Assessment Report Accompanying the Document Proposal for a Regulation of the European Parliament and of the Council on Standard Essential Patents and Amending Regulation (EU) 2017/1001, SWD(2023) 124 final (“Impact Assessment”), at 101.

[53] Call for Comments, supra note 1, Question 10.

[54] See, e.g., U.S. Patent Office, Intellectual Property and the U.S. Economy: 2016 Update (2016), available at https://www.uspto.gov/sites/default/files/documents/IPandtheUSEconomySept2016.pdf.

[55] Shayerah Ilias Akhtar, Liana Wong & Ian F. Fergusson, Intellectual Property Rights and International Trade, at 6 (Congressional Research Service, May 12, 2020), available at https://crsreports.congress.gov/product/pdf/RL/RL34292 (“Intellectual property generally is viewed as a long-standing strategic driver of U.S. productivity, economic growth, employment, higher wages, and exports. It also is considered a key source of U.S. comparative advantage, such as in innovation and high-technology products. Nearly every industry depends on it for its businesses. Industries that rely on patent protection include the aerospace, automotive, computer, consumer electronics, pharmaceutical, and semiconductor industries.”).

[56] See, e.g., Martina F. Ferracane & Hosuk Lee-Makiyama, China’s Technology Protectionism and Its Non-negotiable Rationales, ECIPE (Jun. 2017), available at https://ecipe.org/publications/chinas-technology-protectionism. Consider that, even for actual citizens of the People’s Republic of China, individual rights are legally subordinate to “the interests of the state.” Const. of the People’s Rep. of China, Art. 51, available athttp://www.npc.gov.cn/englishnpc/constitution2019/201911/1f65146fb6104dd3a2793875d19b5b29.shtml. One has to imagine that the level of legal protections afforded foreign firms is no better, and surely must be subordinate to the objectives of China’s industrial policy, including the goal of leapfrogging the United States in IP production. See, e.g., Karen M. Sutter, “Made in China 2025” Industrial Policies: Issues for Congress (Congressional Research Service, Aug. 11, 2020), available at https://sgp.fas.org/crs/row/IF10964.pdf.

[57] See China Is Becoming More Assertive in International Legal Disputes, The Economist (Sep. 18, 2021), https://www.economist.com/china/2021/09/18/china-is-becoming-more-assertive-in-international-legal-disputes (“In the past year Chinese courts have issued sweeping orders on behalf of Chinese smartphone-makers that seek to prevent lawsuits against them in other countries over the use of foreign companies’ intellectual property… so that they (rather than foreign courts) can decide how much Chinese firms should pay in royalties to the holders of patents that their products use.”).

[58] See Matthew Laight, Shifting landscape in SEP FRAND litigation – 2021 will see hard fought disputes in China and India, digital business (Dec. 9, 2020), https://digitalbusiness.law/2020/12/shifting-landscape-in-sep-frand-litigation-2021-will-see-hard-fought-disputes-in-china-and-india.

[59] See RPX Corporation, China: Chinese Courts Can Set Global SEP License Terms, Rules Supreme People’s Court, Mondaq (Oct. 21, 2021), https://www.mondaq.com/china/patent/1120114/chinese-courts-can-set-global-sep-license-terms-rules-supreme-people39s-court.

[60] Id.

[61] See Rush Doshi, Emily De La Bruye?re, Nathan Picarsic, & John Ferguson, China as a “Cyber Great Power”: Beijing’s Two Voices in Telecommunications, Brookings Institute Foreign Policy Paper (Apr. 2021) at 16, available at https://www.brookings.edu/wp-content/uploads/2021/04/FP_20210405_china_cyber_power.pdf. (“In March 2018, Beijing launched the China Standards 2035 project, led by the Chinese Academy of Engineering. After a two-year research phase, that project evolved into the National Standardization Development Strategy Research in January 2020. The ‘Main Points of Standardization Work in 2020’ issued by China’s National Standardization Committee in March 2020 outlined intentions to ‘strengthen the interaction between the standardization strategy and major national strategies.’”).

[62] Quoted in id.

[63] Id. “The phrase ‘cyber great power’ is a key concept guiding Chinese strategy in telecommunications as well as IT more broadly. It appears in the title of almost every major speech by President Xi Jinping on China’s telecommunications and network strategy aimed at a domestic audience since 2014. But the phrase is rarely found in messaging aimed at external foreign audiences, appearing only once in six years of remarks by Foreign Ministry spokespersons. This suggests that Beijing intentionally dilutes discussions of its ambitions in order not to alarm foreign audiences.” Id. at 3 (emphasis added).

[64] See Danny Russel & Blake Berger, Is China Stacking the Technology Deck by Setting International Standards?, The Diplomat (Dec. 2, 2021), https://thediplomat.com/2021/12/is-china-stacking-the-technology-deck-by-setting-international-standards.

[65] Emily de la Bruyere, China’s Quest to Shape the World Through Standards Setting, Hinrich Foundation (Jul. 2021), at 11 (emphasis added), available at https://www.hinrichfoundation.com/research/article/tech/china-quest-to-shape-the-world-through-standards-setting.

[66] Although China is currently under-represented in most SDOs, that is already rapidly changing. See Justus Baron & Olia Kanevskaia, Global Competition for Leadership Positions in Standards Development Organizations, Working Paper (Mar. 31, 2021), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3818143. As Baron and Kanevskaia note, “[t]he surge in the number of leadership positions held by Huawei… [have] raised concerns that… Huawei [may] gain an undue competitive advantage over Western commercial and strategic interests.” Id. at 2.

[67] Updegrove, supra note 19.

[68] See id. at 30-36 (surveying the economic benefits from standardization). See also Soon-Yong Choi & Andrew B. Whinston, Benefits and Requirements for Interoperability in the Electronic Marketplace, 2 Tech. in Soc’y 33, 33 (2000) (“Economic benefits of interoperability result in lowered production or transaction costs typically utilizing standardized parts or automated processes. In the networked economy, the need for interoperability extends into an entire commercial processes, market organizations and products.”).

[69] Anna Gross, Madhumita Murgia & Yuan Yang, Chinese Tech Groups Shaping UN Facial Recognition Standards, Financial Times (Dec. 1, 2019), https://www.ft.com/content/c3555a3c-0d3e-11ea-b2d6-9bf4d1957a67 (“‘The drive to shape international standards… reflects longstanding concerns that Chinese representatives were not at the table to help set the rules of the game for the global Internet,’ the authors of the New America report wrote. ‘The Chinese government wants to make sure that this does not happen in other ICT spheres, now that China has become a technology power with a sizeable market and leading technology companies, including in AI.’”).

[70] Russel & Berger, supra note 67.

[71] Request for Comments, supra note 1,  Question 11.

[72] Igor Nikolic, Licensing Negotiations Groups for SEPs: Collusive Technology Buyers Arrangements? Their Pitfalls and Reasonable Alternatives, Les Nouvelles 350 (2021).

[73] Hector Axel Contreras & Julia Brito, Patent Pools: A Practical Perspective – Part II, Les Nouvelles 39 (2022).

[74] Unwired Planet v Huawei [2017] EWHC 711 (Pat).

[75] TCL v Ericsson, Case No. 8:14-cv-003410JVS-DFM (C.D. Cal. 2018); TCL v Ericsson, 943 F.3d 1360 (Fed. Cir. 2019)

[76] Interdigital v Lenovo [2023] EWHC 539 (Pat) 733.

Executive Summary

This study assesses the likely consequences of implementing the Credit Card Competition Act (CCCA), which proposes to require issuers of most Visa and Mastercard branded credit cards in the United States to include a second network on their cards, and to allow merchants to route transactions on a network other than the primary network branded on the card.

Proponents of the Credit Card Competition Act (CCCA) claim that it would “enhance credit card competition and choice in order to reduce excessive credit card fees.” In fact, by forcing most U.S. credit-card issuers to include a second network on all their cards, the CCCA would remove the choice of network from the issuer and cardholder, and place it in the hands of the merchant and the acquiring bank.

There is some uncertainty as to the legislation’s anticipated effects, as nothing quite like it has ever been implemented anywhere in the world. We can, however, make some inferences based on the known effects of prior regulations driven by similar motives, in the United States and in such jurisdictions as Europe and Australia.

The primary U.S. payment-card networks—Visa, Mastercard, American Express, and Discover—constantly vie with one another to attract customers, investing billions of dollars in innovations that improve the user experience and reduce fraud and theft.

At the same time, hundreds of banks and credit unions compete to offer a broad range of credit cards to American consumers, choosing the network for each card based on the fit between the network’s terms, the card’s purposes, and its intended market.

Credit cards offer numerous benefits, including access to credit (interest-free, if paid in full by the due date), fraud protection, and chargebacks. Many also offer purchase insurance, fee-free international transactions, and consumer rewards like loyalty points and cash back.

Many rewards cards are co-branded with partners such as airlines, hotels, and retailers. The relationship between partners and card issuers is highly synergistic, with issuers generating revenue—due to increased use and associated interchange fees—while partners receive payments for rewards, marketing, and other ancillary benefits (such as lounge access, in the case of airlines). For the top six U.S. airlines alone, these deals represent more than 5% of total revenue—and five times their net revenue.

Credit-card rewards, including cash back and travel points, have become an important part of many consumers’ budgeting decisions. Indeed, it is not uncommon for consumers to have two or three different rewards credit cards, enabling them to choose which to use at time of a purchase based, at least in part, on the rewards they receive from any particular card.

While the CCCA would likely reduce the interchange fees paid by acquiring banks to issuing banks, overall bank fees are unlikely to fall dramatically. Rather, banks would shift fees from interchange to other sources of revenue, including late fees and interest.

The reduction in interchange fees would almost certainly significantly reduce rewards and other benefits to cardholders, as happened when price controls were imposed on debit cards following the implementation of a provision of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 known as the “Durbin amendment,” after sponsoring Sen. Richard Durbin (D-Ill.), who is also lead sponsor of the CCCA. The reduction in interchange fees, in turn, would make certain types of cards less viable. As such, the CCCA would reduce choice for consumers.

Exempted card issuers—especially those of the large three-party networks, American Express and Discover—would likely benefit from the CCCA, as they would still be able to offer rewards and the security of their networks would not be affected.

Merchants who partner with exempted three-party card issuers also would almost certainly benefit, at the expense of other merchants whose co-branded cards are issued by banks that are covered by the legislation. For example, Delta Airlines, which has a card co-branded with American Express, would benefit at the expense of all other airlines. Merchants that co-brand with a three-party card would not only benefit from higher merchant fees, but also from customers switching to receive higher levels of loyalty rewards. Moreover, those who currently spend the most on their co-branded cards would likely be most motivated to switch.

Given the relatively low margins of the U.S. airline industry and the significant proportion of revenue that loyalty rewards represent, the combination of reduced loyalty revenue and reduced customer revenue could be absolutely devastating for the industry (except, as noted, for Delta).

To make matters worse, the CCCA may also affect many airlines’ costs of capital. For example, a reduction in expected revenue from the sale of rewards could result in credit rating agencies downgrading the bonds that United and American Airlines’ rewards-program subsidiaries issued during the COVID-19 pandemic. That could trigger covenants requiring the parent companies to post additional capital, which would, in turn, increase the parents’ capital costs.

In general, the combination of reduced revenue and reduced loyalty-program memberships—leading to lower revenue from higher-value customers—would reduce airlines’ expected future profitability, which would increase capital costs. This may not pose a problem in periods when demand for air travel is high. In a downturn, however, it could result in a bankruptcy—previously avoided due to the airline’s ability to securitize its loyalty program.

One potential outcome is that bank issuers and airlines choose to cancel their co-branded agreements by mutual consent, so that the airlines could make similar arrangements solely with three-party card networks. While this would clearly be beneficial for those three-party networks, and could mitigate the harm to the airlines, it would be enormously costly, and the losers would be issuers, four-party networks, cardholders (especially those with lower credit scores who did not qualify for the three-party-network cards), and the U.S. economy as a whole.

It is also possible that issuers will do what they appear to have done in the EU: increase interest rates and late fees so that they can continue to offer some level of rewards. In that case, the CCCA would have brought about what some critics of credit-card rewards have previously falsely accused issuers of doing: using credit cards to transfer wealth from lower-income, lower-spending consumers who maintain a revolving balance to higher-income, higher-spending consumers who pay off their balances every month.

Either way, the CCCA effectively picks winners and losers. The winners will be three-party cards—especially American Express—and merchants that co-brand with those cards, such as Delta (and their customers), as well as big-box retailers. The losers will be Visa, Mastercard, the other airlines, the card issuers, and their customers. Overall, merchants are also likely to lose, as consumers spend less, which could translate into lower rates of economic growth. Unfortunately, the number and scale of those who lose is likely to be far greater than the number and scale of those who win.

I.        Introduction

Over the past 20 years, payment cards have become increasingly vital to the U.S. economy, largely replacing checks as the preferred means of making a whole range of payments. Underpinning this shift have been innovations in payments technologies that have made them quicker, more convenient, more secure, and less costly for both consumers and merchants.1F[1] These innovations have been driven by competition:

• The primary U.S. payment-card networks—Visa, Mastercard, American Express and Discover—constantly vie with one another to attract and retain customers, investing billions of dollars in innovations that improve the user experience and reduce fraud.
• At the same time, hundreds of banks and credit unions compete to offer a wide range of credit cards to American consumers. Those issuers choose the four-party network for each card, based on the fit between the network’s terms, the card’s purposes, and its intended market.
• Meanwhile, the two major three-party networks—American Express and Discover—compete both with each another and with the large issuers and the four-party networks over which they operate.

A.      Counterparty, Default, and Collection Risk

Credit-card issuers guarantee payment to merchants, so long as those merchants comply with the terms and conditions set by the card network.[2] In so doing, credit cards provide a means of payment that has lower counterparty risk for the merchant than checks. At the same time, card issuers effectively assume the risk of default and collection.

Back in 2010, Sen. Richard Durbin (D-Ill.) himself recognized that operating credit cards is an expensive enterprise that entails counterparty, default, and collection risk, which is why credit cards were excluded from the original Durbin amendment. As he noted at the time:

About half of the transactions that take place now using plastic are with credit cards, and there is a fee charged—usually 1 or 2 percent of the actual amount that is charged to the credit card. It is understandable because the credit card company is creating this means of payment. It is also running the risk of default and collection, where someone does not pay off their credit card. So, the fee is understandable because there is risk associated with it.[3]

B.      Understanding Interchange Fees

For early card-payment systems, offering a means of payment and being exposed to counterparty, collection, and default risk were pretty much the core features of the product. This is because there were only two parties: the merchant and the consumer. The “card” (a metal plate) enabled merchants to maintain a record of credit provided to regular customers, who would then settle up at the end of the month.3F^[4]

So, had Sen. Durbin been referring to the Charge Plate—or to its modern equivalent, which are merchant-issued charge cards—his characterization of the costs would have been largely correct. But nearly all modern payment networks are either three- or four-party systems that are fundamentally more complex.

1.        Three- and four-party cards

In the 1950s, Diners Club and then American Express both established “three-party” systems, which enabled consumers to use the same card at multiple merchants.4F^[5] In a three-party system, the card issuer pays merchants directly, and bills and collects from cardholders directly.5F^[6]

The following decade, several organizations developed “four-party” systems, which have four main parties: issuer, consumer, merchant, and acquirer. The issuer contracts with the consumer, providing the card, issuing bills, etc. The acquirer contracts with the merchant, making payment. The rules of the system are set by the network operator, which also facilitates settlement between the issuer and the acquirer, and monitors for fraud and other abuse.6F^[7] Visa and Mastercard are the primary global four-party networks.

2.        Two-sided markets

One of the major challenges faced by both three- and four-party payment systems is to persuade both merchants and consumers of their value. If too few merchants accept a particular form of payment, consumers will have little reason to hold it and issuers will have little incentive to issue it. Likewise, if too few consumers hold a card, merchants will have little reason to accept it.

Conceptually, economists describe such scenarios as “two-sided markets”: consumers are on one side, merchants on the other, and the payment system acts as the platform that facilitates interactions between them.7F^[8] While payment cards are a prominent example of a two-sided market, there are many others, including newspapers, shopping malls, social-networking sites, and search engines. Indeed, the rise of the internet has made two-sided markets practically ubiquitous.

All platform operators that facilitate two-sided markets face essentially the same challenge: how to create incentives for participation on each side of the market to maximize the joint net benefits of the platform to all participants—and to allocate costs accordingly.8F^[9] Thus, the platform operator can be expected to set the respective prices charged to participants on each side of the market to achieve this maximand.9F^[10] If the operator sets the price too high for some consumers, they will be unwilling to use the platform; similarly, if the operator sets the price too high for some merchants, they will not be willing to use the platform. As the U.S. Supreme Court put it:

To optimize sales, the network must find the balance of pricing that encourages the greatest number of matches between cardholders and merchants.^[11]

3.        Transaction fees

This brings us to transaction fees, which are the primary mechanism that credit-card-network operators use to balance the market. In three-party systems (American Express and Discover), the card-network operator acts as both issuer and acquirer, and charges merchants a card-processing fee (typically a percentage of the transaction amount) directly. In four-party systems, the issuer charges the acquirer an “interchange fee” (set by  the networks) that is then incorporated into the fees those acquirers charge to merchants (called a “merchant-discount rate” in the United States). The schematics in Figure 3 show how these different systems operate.

The interchange fees charged on four-party cards vary by location, type of merchant, type and size of transaction, and type of card. An important factor determining the size of interchange fee charged to a particular card is the extent of benefits associated with the card—and, in particular, any rewards that accrue to the cardholder.

The various three- and four-party payment networks have been engaged in a decades-long process of dynamic competition, in which each has sought—and continues to seek—to discover how to maximize value to their networks of merchants and consumers. This has involved considerable investment in innovative products, including more effective ways to encourage participation, as well as the identification and prevention of fraud and theft.^[12]

It has also involved experimentation with differing levels of transaction fees. The early three-party schemes charged a transaction fee of as much as 7%.15F^[13] Competition and innovation (including, especially, innovation in measures to reduce delinquency, fraud, and theft) drove those rates down. For U.S. credit cards, interchange fees range from about 1.4% to 3.5%, while the average is approximately 2.2%.18F^[14]

In general, economists have concluded that the “optimal” interchange fee is elusive, and that the closest proxy is to be found through unforced market competition. They have therefore cautioned against intervention without sufficient evidence of a significant market failure.25F^[15]

C.      Regulation: In Whose Interests?

Despite these cautions, governments have intervened in the operation of payment systems in various ways. As we have documented previously, many of these regulations have slowed the shift toward more innovative, quicker, and more convenient payment systems, while also reducing other benefits and harming, in particular, poorer consumers and smaller merchants.2F[16]

Introduced in June 2023 by Sens. Richard Durbin (D-Ill.), Roger Marshall (R-Kan.), Peter Welch (D-Vt.), and J.D. Vance (R-Ohio), the Credit Card Competition Act of 2023[17] would continue this trend, to the detriment of consumers and businesses. As this paper documents, co-branded cards generate significant revenue for the merchants whose brand appears on the card. As Section II documents, this appears to be particularly true for airlines. While many other merchants also have valuable co-branded agreements, they generally represent a much lower proportion of total revenue. Hence, assessing the potential effect of the CCCA on airline co-branded credit cards—and on the airlines themselves—is particularly important.

As documented in Section IV, there are broadly two potential outcomes of the CCCA with respect of U.S. airlines:

• Businesses could implement workarounds that minimize the law’s effects. These workarounds are not costless; among other things, they would entail rewriting hundreds of millions of contracts. Issuers, merchants, and consumers would bear those costs. There would also be a significant redistribution of revenue and profits away from the largest four-party card issuers and payment networks and toward the two major three-party networks—perhaps especially American Express. And there would be a smaller redistribution of revenue and profits away from the larger airlines that currently have co-branded cards with Visa and Mastercard (especially American, United, Southwest, Alaska, and JetBlue) toward Delta, which is the one major domestic airline that has a co-branded card with American Express.
• If businesses are unable to implement adequate workarounds, the act’s effects could be much more severe. Most significantly, with the exception of Delta, the major airlines could potentially lose billions of dollars in revenue, mainly because of the reduction in revenue from co-branded cards, but also because some proportion of flyers would likely switch to Delta to take advantage of the more attractive benefits on Delta’s existing co-branded credit card. This, in turn, would affect airlines’ ability to operate some marginal routes, perhaps leading to a spiral of defections to Delta, which would become a huge beneficiary, as it would be relatively more profitable and attract additional fliers.

While the second outcome would clearly be worse, in both cases, Americans would have choices taken away, costs would increase, and economic growth would be adversely affected. Moreover, far from reducing merchants’ costs, most merchants would be adversely affected, as the costs of acquiring credit cards would not fall and could, indeed, rise (and, of course, merchants with co-branded loyalty-rewards cards would suffer substantial revenue losses). In short, there is basically no scenario in which the Credit Card Competition Act is actually good for competition, American consumers, or the U.S. economy as a whole.

D.     Overview of the Study

The study proceeds as follows:

• Section II discusses the nature and economics of loyalty-rewards programs, with a particular focus on airline-rewards programs. It then explains co-branded credit cards and describes some of the major airline co-branded credit-card partnerships, including their likely revenue.
• Section III provides a brief overview of the CCCA.
• Section IV considers some of the primary examples of interchange-fee price controls and routing regulations that have been implemented in the United States and other jurisdictions.
• Section V considers, in detail, the potential effects of the CCCA. It discusses various implementation scenarios and the likely effects of these scenarios on the rewards received by holders of airline co-branded cards, on the behavior of those cardholders, and on the airlines themselves.
• Section VI offers some concluding remarks.

II.      Airline Loyalty-Rewards Programs and Co-Branded Credit Cards

Loyalty-rewards programs have existed for hundreds of years. The first documented program in the United States was established in 1793 by a merchant in Sudbury, New Hampshire, who gave away copper tokens to customers, which could be redeemed for goods.[18] Over time, programs became more sophisticated, with copper tokens replaced, first, by stamps and, later on, by plastic cards with magnetic stripes that encoded the owner’s account information (reward information being recorded on a central database that could be accessed using the card, enabling rewards to be deposited or used). These days, rewards are mostly held in online accounts and accessed via websites and mobile apps, although cards are often still distributed—albeit mainly symbolically.

While we are mainly concerned here with airlines loyalty-rewards programs, and specifically with the role of credit cards co-branded by those programs, it helps to have a more general appreciation of the nature and function of loyalty-rewards programs. Toward that end, this section begins with a basic explanation of the economics of loyalty-rewards programs. It then explores the nature and function of credit-card reward programs, before discussing airline/credit-card co-branded reward programs in more detail.

A.      The Economics of Loyalty-Rewards Programs

Loyalty-rewards programs function primarily as marketing tools to encourage customers to become and remain loyal to a particular merchant. Program participants typically receive points toward rewards each time they make a purchase associated with the program, creating incentives to buy goods and services from that merchant.

These incentives are enhanced by structuring the programs in tiers and making them time-limited, so that participants who purchase more goods or services in a particular period receive higher levels of rewards. Such features are prominent in airline-reward programs, which typically offer inducements to participants in the form of upgrades, waived baggage fees, and use of airport lounges, which become available upon spending a certain amount over the course of a year.[19]

Loyalty-reward programs that distribute specific goods or services in return for reward points, coupons, or stamps likely benefit from the ability to purchase goods or services at a bulk discount.[20]

Merchants may also use rewards redemptions as a means to practice price discrimination, offering specific goods and services to reward-program participants for reduced reward redemptions. For example, airlines typically offer seats for fewer reward points during off-peak periods. Such discounts reduce the marginal cost of the rewards program, enabling merchants to make use of otherwise-unfilled capacity or to sell bulk-purchased goods, while simultaneously providing additional benefits to loyal customers.

Card-based and digital (i.e., app-based or online) reward programs also collect data on the purchasing habits of program participants. As a result, program operators and partners can target marketing at specific participants and more effectively build longer-term customer relationships with them.

B.      Airline-Rewards Programs

American Airlines established the first airline loyalty-rewards program, AAdvantage, in 1981.[21] The other major carriers soon followed suit, realizing that such programs can be an effective means to offer incentives for loyalty. The standard loyalty-rewards program was boosted in 1982 when American Airlines introduced a “gold” tier for higher-value customers.[22] Again, other airlines followed suit, and most have since developed multiple tiers. The evidence shows that airline loyalty-reward schemes are highly effective ways to attract and retain high-value customers.[23]

The value of airline loyalty-reward programs was demonstrated in an unusual way during the COVID-19 pandemic. The collapse in demand for air travel caused more than 40 airlines around the world to file for bankruptcy.[24] Initially, some U.S. carriers issued bonds with very high coupons, as they hemorrhaged cash.[25] Then, in June 2020, United Airlines created a separate bankruptcy-remote entity for its rewards programs, and used it as collateral to issue $5 billion in bonds at a more favorable rate than the airline itself would have received.[26] American and Delta took the same approach.[27]

C.      Credit-Card Reward Programs

Credit-card rewards programs are similar in many elements of their basic operation to other reward programs. Card users receive rewards either in the form of cashback or points (or “miles”) that can be redeemed for various goods and services (the specific goods and services available vary, depending on nature of the rewards-program operator and any partners or affiliates).

Many card issuers offer credit cards that are co-branded with merchants, ranging from retailers to hotels. Among the most popular cards are those co-branded with airlines. Before delving into the particulars of airline co-branded cards, however, it is worth briefly considering the mechanics of co-branded cards in general.

Each co-branded card offering exists by way of an agreement between the card issuer and the co-brand entity. This agreement typically specifies the amount the card issuer will pay the co-brand entity for the purchase of loyalty-reward points, as well as marketing opportunities. These agreements enable issuers, in turn, to make further agreements with cardholders, offering them specific rewards in return for specific spending amounts.

By offering rewards, card issuers provide card holders with incentives to use their card. Meanwhile, the rewards themselves also create loyalty toward the co-brand entity. And the co-brand entity is typically able to adjust the redemption rate of loyalty rewards in order to encourage the use of rewards in ways that reduce the marginal cost of the rewards redemption to the co-brand entity. That, in turn, enables the co-brand entity to offer rewards to card issuers at a discount. In this way, rewards programs can generate significant profits for co-brand entities and issuers, while generating loyalty to the brand and the card for cardholders.

Credit-card-based reward programs can be a highly effective way both to increase the use of cards and to enhance customer loyalty. Survey data demonstrate the effectiveness of rewards programs as a means of encouraging loyalty. A 2015 survey by Technology Advice of U.S. shoppers found that more than 80% of respondents said they were more likely to shop at stores that offered loyalty programs.[28]

Credit-card issuers, in turn, fund the programs partly by charging annual fees to users and partly by charging interchange fees to merchants.

Merchants undoubtedly benefit from credit-card-reward programs both directly and indirectly. Direct benefits come from the ability to target marketing to reward-program members through discounts, additional rewards, and other inducements. As noted, card-based rewards programs enable merchants to customize marketing to specific individuals and groups based on information gathered through card use about their purchasing habits. This can result in a substantial increase in spending per-transaction (known as “ticket lift”).

Research by Mastercard, for example, found that international travelers to the United States who were offered incentives to shop at certain merchants spent four times as much on their cards as cardholders not redeeming such offers.[29] Indirect benefits come from increased use of credit cards in general, which leads to increased spending, due to reduced liquidity constraints, as well as reduced transaction costs and better transaction management.

Credit-card issuers also benefit from credit-card rewards programs, through additional card uptake and usage, as well as from fees charged to merchants and third-party reward-card operators for transaction-related information that better enables them to target marketing efforts.[30]

Arguably the greatest beneficiaries of reward programs, however, are consumers with reward credit cards. Such consumers benefit directly, both from the rewards themselves and from the various additional inducements offered by merchants and card issuers as part of marketing efforts. A survey by Ipsos conducted at the end of 2020 found that 60% of Americans consider credit-card rewards to be “very important” for them, while over half said the prospect of rewards influences their purchasing decisions.[31] Meanwhile, a more recent survey by WalletHub found that 80% of respondents said that inflation had made them more interested in credit-card rewards.[32]

Moreover, due to the better targeting of these inducements made possible by the use of individual transaction data, owners of rewards credit cards likely receive offers that are more relevant than poorly differentiated mass marketing and advertising. In the WalletHub survey, 58% of Americans said they go out of their way to spend at merchants who offer additional credit-card rewards.[33]

D.     Airline/Credit-Card Co-Branded Reward-Program Partnerships

Many merchants with loyalty-rewards programs partner with affiliated (non-competing) merchants to expand their program’s reach. Airlines notably partner with providers of related travel services, such as hotels and car-rental services, offering additional loyalty-rewards points in return for spending dollars at those partners. The partners in these programs purchase the loyalty-rewards points from the airlines, thereby generating additional revenue for the airline.

1.        The value of airline loyalty-reward programs

In 2022, loyalty-rewards programs represented 7.6% of total revenue for the top six U.S. domestic airlines (“loyalty income” column in Table 1). Given the airlines’ relatively thin profit margins (“net income” column in Table 1), this revenue is clearly important even in good times. Indeed, in 2019, the net cash income of the loyalty-rewards programs for the three largest U.S. airlines was $7.8 billion and the margin on those programs ranged from 39% to 53%.[34]

[35]

But loyalty-rewards income can be even more important during downturns. During the 2009-2010 recession, both American Airlines and Delta reported pre-selling $1 billion of loyalty rewards to their co-branded credit-card issuers (Citibank and American Express, respectively).[36] And during the COVID-19 pandemic, the airlines were essentially kept afloat by their loyalty-rewards programs, in general, and their co-branded cards, in particular.

In 2020, for example, American Airlines sold $3.65 billion of loyalty rewards, of which $2.9 billion came from sales to co-branded cards and other partners, resulting in adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) for the loyalty-rewards program of $2.1 billion.[37] It is noteworthy that those partner-rewards sales were only 25% lower in 2020 than in 2019, suggesting that co-branded cards were responsible for about 70% of the total.[38] Meanwhile, Delta, United, and American raised more than $10 billion by issuing debt backed by their loyalty programs, enabling them to avoid bankruptcy.[39]

2.        The value of credit-card co-branded partnerships

For airlines, the most significant loyalty-reward partnership is with credit-card issuers.[40] While the airlines do not usually break out the numbers specifically for co-branded cards, they are clear in their annual reports about the importance of their partnerships with credit-card issuers. Consider the following four examples:

• American Airlines’ 2022 annual report noted that: “During 2022 and 2021, cash payments from co-branded credit card and other partners were $4.5 billion and $3.4 billion, respectively.”[41]
• United Airlines’ 2022 annual report noted that: “Other operating revenue increased $664 million, or 31.8% [to 2.75 billion], in 2022 as compared to 2021, primarily due to an increase in mileage revenue from non-airline partners, including credit card spending recovery with our co-branded credit card partner….”[42]
• Delta Airlines’ annual report noted that revenues from its loyalty program “are mainly driven by customer spend on American Express cards and new cardholder acquisitions.” Meanwhile, the company’s accounting of “miscellaneous income” was “primarily composed of lounge access, including access provided to certain American Express cardholders, and codeshare revenues.” In 2022, income from the loyalty program was $2.58 billion, while miscellaneous revenue was $894 million.[43] In total, the two revenue streams represented $3.47 billion.
• In 2022, Southwest declared $3.03 billion in “passenger loyalty” related revenue.[44] As the company’s annual report explained: “Passenger loyalty – air transportation primarily consists of the revenue associated with award flights taken by loyalty program members upon redemption of loyalty points.” Southwest accounts for loyalty points on an accrual basis as a liability, which becomes “revenue” when they are spent. Southwest separately accounts for “other revenues” which “primarily consist of marketing royalties associated with the Company’s co-brand Chase® Visa credit card, but also include commissions and advertising associated with Southwest.com ®.”[45] It notes: “The Company recognized revenue related to the marketing, advertising, and other travel-related benefits of the revenue associated with various loyalty partner agreements including, but not limited to, the Agreement with Chase, within Other operating revenues. For the years ended December 31, 2022, 2021, and 2020 the Company recognized $2.1 billion, $1.4 billion, and $1.1 billion, respectively.”[46]

As these descriptions indicate, revenues to airlines from co-branded cards are a combination of loyalty rewards, which issuers purchase from the airlines and then allocate to cardholders in accordance with the terms of agreements between the issuers and cardholders; payments for marketing, which includes such items as sending promotional materials to the airlines’ lists of loyalty-rewards members; and payments for ancillary benefits, such as lounge access for some cardholders.

Previous estimates indicate that the proportion of “loyalty revenue” attributable to co-branded credit cards is in the 70% to 80% range.[47] At the lower end of that range (70%), the top six airline co-branded cards would have generated just over $10 billion in value in 2022. Plausibly, the number is somewhat higher. As such, revenue from co-branded cards would represent at least 5% of the operating revenue of the six largest airlines and five times those airlines’ net revenue.

Per the discussion above about the beneficiaries of co-branded reward programs, it seems reasonable to infer that airline co-branded reward cards are highly valued by consumers, airlines, the partners, and the card issuers.

III.    The Credit Card Competition Act

The Credit Card Competition Act of 2023 (CCCA) was introduced in the U.S. Senate on June 7, 2023, by Sens. Richard Durbin (D-Ill.), Roger Marshall (R-Kan.), Peter Welch (D-Vt.), and J.D. Vance (R-Ohio). If enacted, the bill would direct the Federal Reserve Board to promulgate regulations to prohibit banks with assets of $100 billion or more from issuing credit cards[48] that could be used with either (1) only one payment network, (2) only two affiliated payment networks,[49] or (3) only the two payment networks with the “largest market share.”[50] The bill also directs the Federal Reserve Board to promulgate rules prohibiting credit-card processors from limiting merchants’ ability to choose which network they use to route a payment.[51] Furthermore, it would effectively require interoperability of credit-card “tokens.”

While the bill does not explicitly name Visa or Mastercard, they are clearly its primary target. The legislation defines “largest market share” by number of cards issued, which is far larger for both Visa and Mastercard than for any three-party network (i.e., American Express and Discover), primarily because of the intense competition among banks to supply cards.[52] In addition, the Federal Reserve Board would be required to review market share every three years and, if the identities of two largest networks have changed, then the third requirement would no longer apply.[53] As if that weren’t clear enough, the legislation also states that “The regulations … shall not apply to a credit card issued in a 3-party payment system model.”[54]

A.      Prima Facie, Would the CCCA Achieve Its Aims?

In his summary of the act, Sen. Durbin claims:

[T]he giant banks that issue the overwhelming majority of Visa and Mastercard credit cards would have to choose a second competitive network to go on each card, and then a merchant would get to choose which of those networks to use to process a transaction. This competition and choice between networks would incentivize better service and lower cost; in fact, for more than a decade, federal law has required debit cards to carry at least two debit networks and this requirement of a choice of debit networks has fostered increased competition and innovation in the debit network market and has helped hold down fees.

That is, to say the least, an optimistic appraisal of the proposed legislation. While it is highly plausible that the CCCA would, if enacted, lead to a reduction in interchange fees, it appears highly unlikely that it offers incentives for better service. Indeed, the opposite is far more likely. The reason is asymmetric counterparty risk and, specifically, the lack of adequate incentives on the part of larger merchants and acquirers to choose networks that manage fraud risk. This is a problem that Todd Zywicki and I discuss at length in our recent paper on the regulation of routing in payment networks.[55] As we note there:

[E]ach party to a transaction has somewhat different incentives regarding the choice of network. In general, the card issuer and cardholder both have strong incentives to route payments over the main branded network associated with the card, thereby ensuring the use of all the security and anti-fraud protections available from an EMV card, including 3DS for online transactions and the ability for cardholders to place temporary holds on their cards. Some merchants also have incentives to route over the main branded network, especially smaller merchants selling higher-value goods online, given the potential for very expensive chargebacks from unauthorized transactions. However, many other merchants, especially larger high-volume merchants, would have incentives to use the lowest cost routing, especially those that are able to take advantage of the EMV chip and PIN for POS transactions, and those that have their own machine-learning-based fraud monitoring systems that enable them to reduce potential chargebacks on their own. Finally, acquirers generally have less incentive to avoid fraud and stronger incentives to route transactions over the least-cost route.

Since the CCCA would shift the choice of network from the issuer to the merchant and/or acquirer, and since those parties generally have weaker incentives to route transactions over more secure networks with better fraud detection, the likeliest effect is that the CCCA would reduce investments in fraud prevention. As we also noted in the paper on regulating routing, mandating “competition” over routing would cause data fragmentation, with some transactions being routed over the primary network while others are routed over the secondary network. The end result is that the networks’ fraud-detection algorithms would be less effective.[56] Thus, at least when it comes to fraud prevention, the CCCA would likely result in worse service, not better.

B.      The Effect of the CCCA on Airline Co-Branded Rewards Cards

As noted, for reasons explained in Section II, this paper is primarily interested in the effect of the CCCA on airline co-branded rewards cards. Subsequent sections draw on evidence regarding the effects of other interchange-fee regulations, both in the United States and around the world. As a prelude, here is what American Airlines said in its 2022 annual report about the legislation’s potential implications (referring to a near-identical bill that was introduced in the 117^th Congress):

We may also be impacted by competition regulations affecting certain of our major commercial partners, including our co-branded credit card partners. For example, there has previously been bipartisan legislation proposed in Congress called the Credit Card Competition Act designed to increase credit card transaction routing options for merchants which, if enacted, could result in a reduction of the fees levied on credit card transactions. If this legislation were successful, it could fundamentally alter the profitability of our agreements with co-branded credit card partners and the benefits we provide to our consumers through the co-branded credit cards issued by these partners.[57]

IV.    Lessons from Other Interchange Regulations

Over the past four decades, jurisdictions across the world have imposed a range of regulations on payment cards.[58] The most common of these have been price controls on interchange fees. Because three-party card networks are closed loop, there is technically no “interchange” fee and, in many but not all cases, regulations have been interpreted as not applying to them.[59] Some jurisdictions have also imposed other regulations, of which the most relevant for the current analysis is the Durbin amendment’s routing requirements. This section discusses evidence of the effects of these two types of regulation in order to provide insights into what might be expected from the CCCA. (For additional details, see our recent literature review.[60])

A.      Price Controls

In every jurisdiction that has introduced price controls on interchange fees, issuing banks have responded by adjusting their offerings. In the case of credit cards, this has typically meant some combination of reduced card benefits (rewards, insurance, and so on); increased annual fees; and/or increased interest rates. In the case of debit cards, it has means reduced card benefits, increased bank-account fees, and overdraft charges. Some notable examples:

1.        Australia: Fewer rewards, higher annual fees, and companion cards

When the Reserve Bank of Australia (RBA) imposed price controls on credit-card interchange fees in 2003, it made clear that one of its objectives was to reduce the use of credit cards by making them less attractive as a payment solution for consumers.[61] The ploy appears to have worked, as annual fees for rewards credit cards rose, and the rate of rewards fell significantly:

• Between 2002 (the year before the regulation came into effect) and 2004, the annual fee on a “standard” rewards credit card increased by 40% and the fee on a “gold” rewards card rose by 30%, from A$98 to A$128.61F^[62]
• Between 2003 and 2011, the estimated benefit of rewards fell by one third, from $0.81 to $0.54 per dollar spent.59F^[63]

In addition, issuers introduced caps on the total number of rewards that could be earned in a given period.[64] This turns the conventional rewards-card model on its head: instead of creating incentives to use the rewards card more to achieve specific additional benefits, Australian credit-card issuers now provide incentives for rewards-card holders to switch cards when they reach the cap.

Shortly after Australia’s interchange-fee caps for four-party cards came into force in 2003, two banks introduced three-party credit cards with annual fees and rewards similar to those that previously existed on their four-party cards.72F^[65] In addition, several issuers introduced packages of two similar premium rewards cards, one that operates on a four-party network and one that operates on a three-party network.73F^[66] The reason these “companion cards” were created is that far fewer merchants accept three-party cards than four-party cards; with both cards, consumers could use the higher-earning three-party card where it is accepted and the lower-earning four-party card elsewhere.

Unsurprisingly, the market share of three-party cards, while still relatively small, increased considerably following the 2003 regulations. By volume of transactions, three-party cards increased from about 10% in 2002 to about 16% in 2013 (a 60% increase). By value of transactions, they increased their market share from about 15% in 2002 to more than 20% in 2013 (a 33% increase).

In October 2015, the RBA designated American Express Companion Cards a “payment system”74F^[67] and subsequently announced that, as of July 1, 2017, the cards would be subject to the same interchange-fee caps as other designated cards.75F^[68] Following the introduction of these caps, companion cards were discontinued and the market share by volume of three-party cards fell back to between 7% and 8% (but subsequently rose again slightly to about 8%).76F^[69] By value, three-party cards’ market share of transactions also fell steeply after mid-2017, but is now back to about 20%.^[70]

2.        Spain: Fewer rewards, higher interest rates, higher fees

In 2005, the Spanish government introduced gradually tightening price controls on interchange fees by “agreement” with the country’s banks. For credit cards, the controls started at 1.4% in 2006, falling to 0.79% in 2009-10. In response, local issuers reduced the rewards available from cards.57F^[71] Meanwhile, from 2008 to 2010, issuers increased interest rates on credit cards from an average of 3% above the European Central Bank (ECB) base rate in 2005 to 4.6% above base.58F^[72] As a result, income from interest payments was nearly 80% higher from 2006 to 2010 than in 2005, representing a total incremental increase in income from interest over the period of about €2.6 billion (although this could be an overstatement, since we are only comparing to revenue in 2005). At the same time, average annual fees on credit cards rose by 50%, from €22.94 to €34.39, generating incremental revenue over the period of €1.7 billion.

3.        EU: Fewer rewards, higher interest rates, and foreign transaction fees

In 2014, the European Union (EU) adopted the Interchange Fee Regulation (IFR), which imposed price controls on debit- and credit-card interchange fees at 0.2% and 0.3%, respectively, with the regulation taking effect Jan. 1, 2015. The IFR initially applied only to four-party cards (primarily to Visa and Mastercard, but also some domestic payment cards).

In response to the IFR, credit-card issuers significantly reduced rewards on credit cards, or terminated rewards cards altogether.[73] Several airlines have nonetheless continued to co-brand rewards cards. American Express cards were all initially excluded from the rules, so airlines that already had an Amex co-branded card (such as British Airways) were not affected. Following a decision by the European Court of Justice in 2018, however, the IFR was deemed to also apply to co-branded cards issued by three-party networks.

As in Australia, issuers in the EU increased annual fees on cards that already had fees.[74] The total revenue from annual fees fell, however, presumably because consumers switched to cards without fees (Table 2). Issuers nonetheless made up much of the revenue lost from the interchange price controls by increasing interest rates. As noted below, this enabled them to continue to offer rewards. As Table 2 shows, while revenue from interchange fees fell by nearly 50% between 2014 and 2018, issuer revenue related to credit cards fell by less than 5%.[75]

[76]

In addition, while rewards in the EU fell significantly across the board, some co-branded airline-rewards cards in the EU and the United Kingdom (which retained IFR caps on domestic transactions post-Brexit) earn at a rate that is nominally worth the equivalent of 1% to 1.5% of the amount spent on the card—that is, three to five times the interchange fee. For example, American Express (whose co-branded cards are now subject to the same fee caps as four-party cards) offers two British Airways co-branded cards in the UK, one that has an annual fee of £250 and earns 1.5 Avios per £1 on general spend, and 3 Avios per £1 spent on BA. The other card has no annual fee and earns 1 Avio per £1 spent. ^[77] Meanwhile, the value of each Avios is between 0.66 and 1.5p, depending on its use.[78]

There are several feasibly explanations for why the value of rewards exceeds the amount of interchange fees. First, issuers may be able to purchase airline-loyalty rewards at a significant discount. Because airlines know that they will be able to encourage holders to redeem them on flights that otherwise would not be full, the marginal cost is likely much lower than the nominal value. Second, other partner companies that redeem loyalty rewards may also be willing to do so at a discount, knowing that such redemptions both encourage loyalty to that partner and, in some cases, will only represent partial payment for goods and services, thereby acting effectively as a discount on larger purchases. Third, card issuers may be using other income—such as annual fees, interest, and late fees—to cover the shortfall. It is possible that all three explanations are true.

If card issuers in the EU are using additional revenue from higher-interest charges and late fees to cross-subsidize rewards cards—including airline co-branded rewards cards—then the IFR is effectively highly regressive. This is because late fees and interest charges are predominantly paid by individuals with lower credit scores and who spend less on their cards but keep a revolving balance, whereas rewards are earned primarily by people with higher credit scores who pay off their balance each month.

4.        US: Debit cards and the Durbin amendment

When the Federal Reserve adopted Regulation II, implementing the interchange-fee price controls required by the Durbin amendment to Dodd-Frank, some covered issuing banks initially responded by stating that they would introduce consumer fees for the use of debit cards.[79] That idea immediately met with backlash, so the banks instead increased monthly account fees and increased the minimum balance required for free checking, as documented by economists at the Federal Reserve.[80] Banks also essentially eliminated rewards for debit cards. Evidence suggests that the higher bank-account charges and higher minimum-balance requirement for free checking most likely led to a significant increase in the number of unbanked individuals. [81]

Meanwhile, the evidence also suggests that consumers received little, if anything, in return. A survey conducted by economists at the Federal Reserve Bank of Richmond two years after the implementation of Regulation II found that:

[T]he regulation has had limited and unequal impact on merchants’ debit acceptance costs. In the sample of 420 merchants across 26 sectors, two-thirds reported no change or did not know the change of debit costs post-regulation. One-fourth of the merchants, however, reported an increase of debit costs, especially for small-ticket transactions. Finally, less than 10 percent of merchants reported a decrease of debit costs. The impact varies substantially across different merchant sectors.

The survey results also show asymmetric merchant reactions to changing debit costs in terms of adjusting prices and debit restrictions. A sizable fraction of merchants are found to raise prices or debit restrictions as their costs of accepting debit cards increase. However, few merchants are found to reduce prices or debit restrictions as debit costs decrease.[82]

A subsequent study by economists Vladimir Mukharlyamov and Natasha Sarin investigated the Durbin amendment’s effects on consumers using a proprietary dataset of gasoline sales in different ZIP codes.[83] (Gas is a widely consumed commodity sold in a highly competitive market, and is thus arguably the product most likely to see interchange-fee savings passed through.) The researchers found that gas is, “cheaper in ZIP codes with a greater fraction of transactions paid with debit cards issued by large banks,” which suggests that at least some retailers passed on some savings. They note, however, that “the standard deviation of per-gallon gas prices ($0.252) is 168 times larger than the average per-gallon debit interchange savings ($0.0015). Relatedly, total Durbin savings for gas merchants amount to less than 0.07% of total sales. These points render the quantification of merchants’ pass-through with statistical significance.” In other words, whatever savings retailers passed on to consumers were tiny.

At the same time, using data from bank call reports and the Federal Deposit Insurance Corporation’s summary of deposits, Mukharlyamov and Sarin found that banks covered by the price controls “collectively lost $5.5 billion in annual revenue” from interchange fees. And using data from RateWatch, they found those banks “passed 42 percent of these losses through to their customers.”[84] Specifically:

We estimate that the share of free checking accounts fell from 61 percent to 28 percent as a result of Durbin. Average checking account fees rose from $3.07 per month to $5.92 per month. Monthly minimums to avoid these fees rose by 21 percent, and monthly fees on interest-bearing checking accounts also rose by nearly 14 percent. These higher fees are disproportionately borne by low-income consumers whose account balances do not meet the monthly minimum required for fee waiver.[85]

So, while the Durbin amendment served to dramatically reduce interchange fees on debit transactions, the main effect was to increase bank fees for poorer consumers, causing some of them to leave the banking system altogether and likely become reliant on more expensive forms of credit, such as payday loans.

B.      Routing Regulations

The only jurisdiction to have thus far implemented regulations mandating “competition” in network routing is the United States, which included such a mandate for debit cards in the Durbin amendment. Some other jurisdictions, most notably Australia, have contemplated such regulations. But in its most recent report on the matter, the RBA rejected mandatory “least cost routing.”[86] This subsection thus focuses on the effects of the Durbin amendment’s routing requirements.

1.        The Durbin amendment routing requirements

In addition to interchange-fee price controls on “covered” issuers—i.e., banks with assets of at least $10 billion—the Durbin amendment required the Federal Reserve Board to impose routing requirements on the debit transactions of all banks. Specifically, it mandated that these regulations should prohibit issuers and payment networks from imposing network-exclusivity arrangements.[87] In particular, all issuers must ensure that debit-card payments can be routed over at least two unaffiliated networks. It also required the Federal Reserve Board to prohibit issuers and payment networks from restricting merchants and acquirers’ ability to choose the network over which to route a payment.

[88]

As Figure 2 shows, for covered issuers, average interchange fees per-transaction fell to the regulated maximum for both dual-message (signature) transactions and single-message (PIN) transactions immediately following implementation of the Durbin amendment in October 2011. Meanwhile, discounting for inflation, average fees per-transaction for issuers that were exempted from the price controls fell by only about 10% for dual-message transactions, which were not subject to direct competition for routing. For single-message transactions, however, routing was subject increasingly to direct competition, and average fees per-transaction for exempt issuers fell by 30% over the course of eight years; by 2019, fees were only marginally higher than the regulated maximum for covered issuers.

Based on the experience of mandatory routing under the Durbin amendment, then, it seems highly likely that the CCCA would, if implemented, drive down the price of interchange, as proponents want. And issuers would respond as they did to the Durbin amendment, by finding other ways to recoup lost revenue. Consumers would again almost certainly endure the most of this shift through higher card fees, higher interest rates, and fewer benefits, including less generous rewards.

V.      How Would the CCCA Affect Co-Branded Credit Cards?

This section draws on the discussion in Section IV to infer the potential effects the CCCA would likely have on co-branded credit cards. It begins with a discussion of the effect on issuer revenue in general. It then looks at how issuers might address the loss of revenue through, e.g., increases in annual card fees, increases in interest rates and late payment fees, reduction in rewards, reduction in other benefits, and the introduction of “companion cards.” This is followed by a discussion of the potential effect on airlines.

A.      Effect on Issuer Revenue

As noted, the stated intention of the CCCA is to reduce merchants’ costs by lowering interchange-fee revenue. One proponent of the CCCA has claimed that it “could result in annual savings upward of $15 billion.”[89] But this claim is not supported by any evidence; indeed, so far as this author can tell, it seems to have been plucked out of thin air.

While it is likely that interchange-fee revenue will be reduced, it is difficult to know with any degree of precision by how much, or what other effects might occur. (As to the effect on merchant costs—that is quite another matter, as will be discussed later.) Much will depend on which networks issuers include as the secondary networks on their cards. This, in turn, will likely depend on complex negotiations among the issuers, the primary networks, and the various possible secondary networks. Factors that will affect the decision regarding which network is included as a secondary network on a card are likely to include:

• The extent to which the secondary network is able to meet fraud and other security concerns of the issuer. For example, many of the alternative networks were designed to operate with ATMs, and are thus PIN-based single-message systems that do not offer dual-message transmission. Since at least some proportion of transactions on any credit card are likely to require dual-message transmission for the purposes of meeting such EMVCo standards as 3DS (in part, to limit the potential for card-not-present fraud), it is unclear how a single-message (PIN) network could be the secondary network.
• Issues related to brand reputation of the two networks. This could affect, for example, the willingness of three-party networks to function as secondary networks, because those networks have positioned themselves as premium brands. Meanwhile, similar to the issuer concerns, Visa and Mastercard would be understandably reluctant to have a network with poor security and fraud detection as a secondary network on cards bearing their brands.
• Relatedly, three-party networks might be reluctant to function as secondary networks if they expect that participation would result in a reduction in the rates they could charge merchants on their own closed-loop network.
• Whether issuers wish to and are able to issue “companion cards” by partnering with three-party networks as the sole network, as Australian banks did for a while (see Subsection B below), which might also affect three-party cards’ incentives to function as secondary networks.
• Which networks might be prohibited under Article D of the CCCA, which prohibits secondary networks that are either a national security risk or are “owned, operated, or sponsored by a foreign state entity.”[90] This would seem to eliminate China Union Pay, whose member banks are primarily state-owned. And potentially, it could be applied to any network, as “national security risk” is not well-defined.

These factors generally militate against single-message networks, three-party networks, and China Union Pay becoming secondary networks on credit cards. As such, many covered issuers might plausibly choose JCB Co. Ltd. (formerly Japan Credit Bureau) as their secondary network, assuming that JCB is not deemed to be a national security risk. JCB is a member of EMVCo and applies the same basic security standards as other EMVCo companies (Visa, Mastercard, American Express, Discover, and China Union Pay).[91] Unlike China Union Pay, however, JCB is a private enterprise, and so should not fall afoul of Article D of the CCCA. JCB has an agreement with Discover that enables JCB cardholders to use their cards in the United States by running them over the Discover network. By adding JCB as the secondary network, issuers would therefore effectively utilize Discover’s network, including the application of EMVCo rules, such as 3DS, which provides enhanced fraud protection for card-not-present transactions.[92]

Since the JCB secondary network would actually be run over the Discover network, the interchange rates that would be applied would presumably be Discover’s, which are similar on average to those of Visa and Mastercard, but appear to be slightly higher for standard cards and slightly lower for the higher-end rewards-type cards.[93] Assuming cards are programmed to apply interchange rates for somewhat equivalent products, the initial effect of the CCCA on interchange-fee revenue could, in theory, be modest.

That sounds like good news. Over the medium to longer term, however, this artificial “competition” between the networks on the card would almost inevitably lead to a gradual reduction in fees, as each network seeks to attract more users in each category. This is precisely what happened with PIN debit networks for banks and credit unions that were exempted from the Durbin amendment’s price controls on interchange fees. This would continue until each network could barely cover its costs in each category. In that case, the effect on interchange-fee revenue could be devastating.

The analogy here is not to the dynamic competition that drives innovation in conventional markets, guided by a process of price discovery that seeks to provide consumers with better goods and lower prices through the development of more efficient processes that consume fewer resources. The analogy here is, rather, the “tragedy of the commons,” or more precisely, the tragedy of open access. In effect, by forcing networks to compete on price alone—maximizing use, while minimizing expenditure on improvements—the result will be diminution in network quality, just as when anglers chase after fish stocks until they are economically exhausted (too depleted to be worth chasing).[94]

We can push the overfishing analogy further. Initially, fishers often do not notice that they are depleting the stock, but over time, they have to increase the amount of effort they put into fishing until the returns no longer justify the investment. A similar thing could happen with payment networks, with the effects initially being muted by decades of investment in security protocols and the collection of transaction data. But over time, the value of those investments and data will wither.

The solution to the open-access problem has been well-known to economists for more than half a century: establish clearly defined and readily enforceable property rights.[95] This has proved challenging in fisheries, but an increasing number of jurisdictions have developed successful approaches of various kinds.[96]

The irony is that the networks have expressly sought to avoid this tragedy by developing clear rules regarding who has access to the data transmitted from their cards, how it is transmitted, to whom, and under what conditions.

Interchange fees, as they exist today, are one of those rules: they are the default in open-network schemes and exist, at least in part, because of the high costs of negotiating and enforcing many bilateral agreements among banks.^[97] They are set by payment-network operators, who are able to avoid the problems that would arise if individual issuing banks set their own fees. The latter might lead to fees being set at inefficiently high levels in order to maximize issuing-bank revenue, without regard to the impact on the value of the system as a whole.21F^[98]

The CCCA would run roughshod over those rules.

B.      Response by Issuers to Compensate for Revenue Losses

Proponents of the CCCA seem to assume that issuers will simply accept the loss of revenue from interchange fees and do nothing to try to compensate. Based on the experience of both the Durbin amendment and of interchange regulations in other jurisdictions, this is an incorrect assumption.

In practice, it seems almost certain that card issuers would implement one or more of several measures to recover the lost revenue and/or reduce costs. Among other things, they might:

• Increase annual card fees. In Australia, banks increased annual card fees by 30% to 40%. In Europe, they increased them by about 13%.[99] Such fees tend to be regressive, because they are charged at a fixed rate regardless of how much a cardholder spends. Thus, for lower-income cardholders who spend less, such a fee increase would be proportionately more onerous.
• Remove insurance and other benefits. Many U.S. credit cards currently offer cardholders a range of benefits, often including purchase-protection insurance, car-rental insurance, travel insurance, and fee-free international transactions. These benefits were also common on cards issued in the EU prior to the introduction of the IFR, but were removed afterwards. As a result, most cards—including rewards cards—now have limited, if any, insurance and charge a transaction fee of between 2% and 3% for international transactions.
• Increase late-payment fees (if not prohibited from so doing by other regulations) and interest rates. In the EU, issuers increased late-payment fees and interest rates following the introduction of the IFR. Between 2014 and 2016, interest rates on revolving balances rose from an average of 16.2% to 18.8%, while the European Central Bank base rate fell from 0.3% to 0.25%. This implies an increase in average real rates on credit cards of 2.75%. Likewise, in Spain, credit-card interest rates were increased at a substantially faster rate than increases in rates at the European Central Bank, with the result that revenue from interest rose by 80% during the period when IFRs were subject to national price controls on interchange fees, from 2006 to 2010.

The determination of which fees to increase and by how much will depend on issuers’ views regarding the willingness of cardholders to bear such fees. Likewise, the determination of which benefits to withdraw on which cards will be made—possibly simultaneously with the determination of any increase in annual fees (which could be used to cover such benefits in whole or in part)—on the basis of the effects such changes will have on demand for cards.

1.        Responses by issuers of co-branded rewards cards

As noted earlier, issuers typically cover the costs of rewards on co-branded cards through some combination of annual fees and interchange fees. Issuers also often pay for other items, ranging from lounge access for cardholders to marketing fees for promoting the card and related services, the costs of which also must be paid for by some combination of merchants and users.

Since the costs associated with co-branded rewards cards are typically higher than the costs of other non-rewards cards, the effects of the CCCA would likely be much more severe for such co-branded cards. As such, issuers of co-branded cards may seek to implement additional measures in order to recover revenue and ensure that they meet their obligations to cardholders and co-brand partners.

2.        Responses by issuers of airline-rewards co-branded cards

As noted, in the UK and some EU jurisdictions, issuers have continued to co-brand credit cards with airlines. Moreover, while rewards have been reduced significantly, and many other card benefits—such as insurance and fee-free foreign transactions—have largely been eliminated, the amount earned in rewards per euro or pound spent remains notionally higher than the interchange fee on the card. As also noted, there are several possible explanations for this, including that airlines may sell rewards at a discount, or that issuers were able to make up some of the losses on interchange fees by increasing interest rates, late fees, and foreign transaction fees. If the CCCA were enacted, we might see issuers adopt some combination of these approaches.[100]

In Australia, issuers put caps on the amounts of rewards that could be earned. As noted, this effectively inverts the purpose of such rewards, which are intended to engender loyalty, but if the amount that can be earned is capped or the earning rate declines after a certain spend, then users will have incentives at that point to switch to a different card. While this would reduce the loyalty element of the co-branded card (perversely encouraging disloyalty, in fact), U.S. issuers of multiple co-branded cards might be motivated to pursue this approach in order to drive short-term spending on each of their cards, especially if they have agreements to purchase a certain number or rewards at a discounted price.

C.      The Effect on Airlines and Their Response

The effect of the CCCA on airlines will depend very much on which networks become secondary networks, whether issuers are able to issue companion cards, and all the other factors discussed above. But in almost any imaginable scenario, the airlines that currently co-brand four-party credit cards will see a reduction in revenue. In many scenarios, that revenue reduction could be significant—in some cases it could be 5% to 10% of total revenue. While this would be partly offset by a reduction in liability associated with outstanding loyalty-rewards points, there is a timing mismatch effect: The revenue loss will occur in the short term, while the rewards-redemption effect occurs over a longer time horizon.

In addition, to the extent that airlines are unable either to offer companion cards or switch altogether to three-party cards—and thereby offer their loyal customers continued benefits at a similar level to those available on their current cards—there will almost certainly be some attrition of loyalty. In other words, some proportion of fliers who are currently loyal to American, United, Southwest, JetBlue, Alaska, and other smaller airlines with four-party co-branded credit cards will switch to Delta. Moreover, the evidence suggests that those most likely to switch will be those most adversely affected by the change—that is to say, those who tend to spend the most on their co-branded rewards card.

This likely includes many middle-class consumers who live far away from family members and currently value the rewards from their co-branded card highly. To the extent that those individuals are also among the most loyal to the airlines whose co-branded cards they use, this could have a seriously detrimental effect on the profit margins of the other airlines.

The CCCA may also affect many airlines’ costs of capital. For example, at least for United and American Airlines, a reduction in expected revenue from the sale of rewards could result in the downgrading of the bonds issued during the COVID-19 pandemic by the subsidiaries that now own the rewards programs. That could trigger covenants requiring the parent companies to post additional capital, which in turn would increase the parents’ capital costs. In general, the combination of reduced revenue and reduced membership of loyalty programs—leading to lower revenue from higher-value customers—would reduce airlines’ expected future profitability, which would increase capital costs. In times when demand for air travel is high, this may not pose a dramatic problem. It would, however, likely affect fleet investment, which would adversely affect the flying experience and might lead to the termination of some routes. And in a downturn, it could result in the bankruptcy that the airlines previously avoided, thanks to their ability to securitize their loyalty programs.

VI.    Conclusions

This study has focused relatively narrowly on the likely effects of the CCCA on co-branded reward credit cards and the knock-on effects on the co-brand partners, especially airlines. If enacted, however, the law’s effects would be far broader. For example, it would likely cause a reduction in investment in innovation by card issuers and networks for at least two reasons. First, by reducing prospective revenue, the CCCA would reduce network providers’ incentive and ability to invest in innovation. Second, by requiring networks to make tokens interoperable, the CCCA dramatically reduces the incentive to invest in improvements to the security, convenience, and other aspects of tokenized transactions.

Proponents of the Credit Card Competition Act (CCCA) claim that it would “enhance credit card competition and choice in order to reduce excessive credit card fees.” In fact, by forcing the majority of credit-card issuers in the United States to include a second network on all their cards, the CCCA would remove the choice of network from the issuer and cardholder and place it in the hands of the merchant and the acquiring bank.

Indeed, the name of the Credit Card Competition Act would appear to be unintentionally ironic, since one of its main effects would be to reduce competition between issuers, as margins would be reduced, and issuers would be less able to differentiate on the basis of such offerings as co-branded cards (airlines, hotels, retailers). As a result, there would be less pressure to compete on interest rates, which in turn would mean that—as happened in the EU and especially in Spain—issuers would likely increase interest rates in order to offset reduced interchange-fee revenue.

To the extent that issuers use this offsetting revenue from interest to enable them to continue to offer some level of rewards, the CCCA would have brought about what some critics of credit-card rewards have previously falsely accused issuers of doing: using credit cards to transfer wealth from lower-income, lower-spending consumers who maintain a revolving balance to higher-income, higher-spending consumers who pay off their balances every month.[101]

Even if issuers do continue to offer rewards, the evidence from Europe and Australia is that the CCCA would cause such rewards to be diminished significantly, harming consumers both directly and indirectly. The direct harms would come in the form of fewer rewards (except for those consumers who only use three-party cards). The indirect harms would come through the effects on businesses that currently rely heavily on revenue from co-branded cards that would be diminished by the CCCA.

As this study has demonstrated, airlines, in particular, could be adversely affected, leading to reduced fleet investment, termination of routes, and potentially to bankruptcy. There would also likely be a broader adverse effect, as consumers reduce their use of credit cards (including some who give them up), which would result in an overall reduction in consumption—harming both merchants and the broader economy.

Appendix: Routing in Payment Networks

When a cardholder submits a transaction for payment, information regarding that payment is sent over a proprietary network. This is called “routing.” There are, broadly, two types of payment network: single-message (PIN) networks that emerged from ATM networks, and dual-message (signature) networks that were developed by the credit-card networks (Visa, Mastercard, American Express, and Discover). In general, credit cards require dual-message networks, whereas debit transactions can run over either type of network. To understand why, it is worth briefly explaining the mechanics of the two systems.

• Single-message (PIN) debit networks

Single-message networks rely on the PIN stored in the card to authenticate a transaction. As a result, the only message that is required is a notification to the issuing bank to debit the account of the cardholder in the amount they have authorized, and to credit that amount the account of the merchant—less the discount fee, which is paid to the acquiring bank. Because of the nature of the transaction, settlement can be effected over banks’ electronic-funds-transfer (EFT) networks that were initially built to settle transactions at shared ATMs, and then over networks of ATMs.^[102]

• Dual-message (signature) networks

As the name suggests, dual-message networks send two messages: the first is a request for authorization sent to the issuing bank, which confirms the authenticity of the card, checks whether the cardholder has sufficient credit available, and monitors for fraud. If authorized, the second message contains information confirming the amount to be credited to the merchant’s account during clearing and settlement.

For example, if you present your credit card at a sit-down restaurant, the check total would be authorized by the network and a “hold” or “pending transaction” amount would appear on your account. The opportunity to add a tip to the bill permits a second, later message that authorizes payment of the full amount of food, plus a tip to be credited to the merchant. Similar “holds” are also often used by online merchants in order to delay payment (sometimes by as much as several days), thereby reducing the likelihood of fraud and associated chargebacks.^[103]

[1] See Developments in Noncash Payments for 2019 and 2020: Findings From the Federal Reserve Payments Study, Federal Reserve Board, (Dec. 2021), available at https://www.federalreserve.gov/publications/files/developments-in-noncash-payments-for-2019-and-2020-20211222.pdf, along with the various previous studies and associated data, https://www.federalreserve.gov/paymentsystems/frps_previous.htm.

[2] See, e.g., Mastercard Rules, Mastercard, https://www.mastercard.us/en-us/business/overview/support/rules.html (last accessed Nov. 16, 2023); Visa Rules and Policy, Visa, https://usa.visa.com/support/consumer/visa-rules.html (last accessed Nov. 16, 2023).

[3] 156 Cong. Rec. S3,571 (daily ed. May 12, 2010), available at https://www.congress.gov/111/crec/2010/05/12/CREC-2010-05-12-pt1-PgS3569-9.pdf.

[4] Claire Tsosie, The History of the Credit Card, NerdWallet.com (Mar. 15, 2021), https://www.nerdwallet.com/article/credit-cards/history-credit-card; see also Jeremy Norman, The Charga-Plate, Precursor of the Credit Card, Circa 1935 to 1950, HistoryofInformation.com, https://www.historyofinformation.com/detail.php?id=1710 (last accessed Nov. 16, 2023).

[5] See Todd J. Zywicki, The Economics of Payment Card Interchange Fees and the Limits of Regulation, International Center for Law & Economics (Jun. 2, 2010), available at http://laweconcenter.org/images/articles/zywicki_interchange.pdf. Several banks also attempted to establish three-party cards during the 1950s. Most of these were unsuccessful. The exception was Bank Americard, which subsequently became a four-party system and eventually rebranded as Visa.

[6] The issuer may arrange separate underwriting. More recently, the processing of three-party card transactions are sub-contracted to other payment processors, but the fundamental three-party legal arrangements remain the same.

[7] For a more detailed explanation of the operation of payment-card systems, see Zywicki, supra note 5, at 27-30.

[8] See Zywicki, supra note 5; see also Jean-Charles Rochet & Jean Tirole, Two-Sided Markets: A Progress Report, 37 Rand J. Econ. 645 (2006); As the U.S. Supreme Court wrote in Ohio v. American Express Co. (585 U.S. Slip Op, 2018, at 2): By providing these services to cardholders and merchants, credit-card companies bring these parties together, and therefore operate what economists call a “two-sided platform.” As the name implies, a two-sided platform offers different products or services to two different groups who both depend on the platform to intermediate between them.”… For credit cards, that interaction is a transaction…. 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.

[9] Bruno Jullien, Alessandro Pavan, & Marc Rysman, Two-Sided Markets, Pricing, and Network Effects, in Handbook of Industrial Organization (Vol. 4), 485-592, (2021).

[10] Thomas Eisenmann, Geoffrey Parker, & Marshall W. Van Alstyne, Strategies for Two-Sided Markets, Harv. Bus. Rev. (Oct. 2006).

[11] Ohio v. American Express Co. (585 U.S. Slip Op, 2018), at 13.

[12] Zywicki, supra note 5, at 10.

[13] Tsosie, supra note 4.

[14] Visa USA Interchange Reimbursement Fees, Visa Public (Apr. 23, 2022), available at https://usa.visa.com/content/dam/VCOM/download/merchants/visa-usa-interchange-reimbursement-fees.pdf; Mastercard USA Interchange Rates, HELCIM, https://www.helcim.com/mastercard-usa-interchange-rates (last accessed Nov. 16, 2023).  

[15] Jean-Charles Rochet & Jean Tirole, An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems, 2 Rev. Netw. Econ. 69-79 (Jan. 2003).

[16] See Todd J. Zywicki, The Economics of Payment Card Interchange Fees and the Limits of Regulation, International Center for Law & Economics (Jun. 2, 2010), available at http://laweconcenter.org/images/articles/zywicki_interchange.pdf; Todd J. Zywicki, Geoffrey A. Manne, & Julian Morris, Unreasonable and Disproportionate: How the Durbin Amendment Harms Poorer Americans and Small Businesses, International Center for Law & Economics (Apr. 25, 2017); Todd J. Zywicki, Geoffrey A. Manne, & Julian Morris, Price Controls on Payment Card Interchange Fees: The U.S. Experience, George Mason Law & Economics Research Paper No. 14-18, (Jun. 6, 2014).

[17] Credit Card Competition Act of 2023, S. 1838, 118th Cong. § 1 (2023).

[18] James J. Nagle, Trading Stamps: A Long History, The New York Times (Dec. 26, 1971), https://www.nytimes.com/1971/12/26/archives/trading-stamps-a-long-history-premiums-said-to-date-back-in-us-to.html

[19] Michael McCall & Clay Voorhees, The Drivers of Loyalty Program Success, 51 Cornell Hosp. Q. 35 (2010).

[20] This seems to have been an essential part of the business model of trading-stamp programs.

[21] Evert R. de Boera & Sveinn Vidar Gudmundsson, 30 Years of Frequent Flyer Programs, 24 J. Air Transp. Manag. 18-24 (2012).

[22] Id. at 19.

[23] Enny Kristiani, Ujang Sumarwan, Lilik Noor Yulianti, & Asep Saefuddin, Customer Loyalty and Profitability: Empirical Evidence of Frequent Flyer Program, 5 J. Mark. Stud. 62 (2013).

[24] Abigail Ng, Over 40 Airlines Have Failed So Far This Year — And More Are Set to Come, CNBC (Oct. 8, 2020), https://www.cnbc.com/2020/10/08/over-40-airlines-have-failed-in-2020-so-far-and-more-are-set-to-come.html.

[25] For example, on June 30, 2020, American Airlines issued $2.5 billion of bonds dated 2025 with a coupon of 11.75%. American Airlines Inc. Dl-Nts 2020(20/25) Reg. S, Markets Insider,  https://markets.businessinsider.com/bonds/american_airlines_incdl-nts_202020-25_regs-bond-2025-usu02413ae95.

[26] Tracy Rucinski, United Airlines Pledges Loyalty Program for $5 Billion Loan, Reuters (Jun 15, 2020), https://www.reuters.com/article/us-health-coronavirus-united-arlns-idUSKBN23M1PB

[27] So Yeon Chun & Evert de Boer, How Loyalty Programs Are Saving Airlines, Harvard Business Review (Apr. 2, 2021), https://hbr.org/2021/04/how-loyalty-programs-are-saving-airlines.

[28] Cameron Graham, Study: Why Customers Participate in Loyalty Programs, TechnologyAdvice.com (Jul. 23, 2014), http://technologyadvice.com/blog/marketing/why-customers-participate-loyalty-programs.

[29] Michelle Geraghty & Trisha Asgierson, Relationship Rewards: A Game Changer for Financial Institutions, Mastercard (2013), available at https://www.mastercard.us/content/dam/mccom/en-us/documents/relationship-rewards-whitepaper.pdf.

[30] See, e.g., Blake Ellis, The Banks’ Billion-Dollar Idea, CNN Money (Jul. 8, 2011), http://money.cnn.com/2011/07/06/pf/banks_sell_shopping_data/index.htm.

[31] Marie-Pierre Lemay & Negar Ballard, Majority Say Credit Card Rewards Are Very Important, and Drive Their Card Usage, Ipsos (Jan. 12, 2021), https://www.ipsos.com/en-us/majority-say-credit-card-rewards-are-very-important-and-drive-their-card-usage.

[32] John S Kiernan, 2023 Credit Card Rewards Survey, WalletHub (Jun. 13, 2023), https://wallethub.com/blog/credit-cards-rewards-survey/63067.

[33] Id.

[34] American Airlines, AAdvantage Investor Presentation March 2021, SEC Form 8-K (Mar. 8, 2021), https://americanairlines.gcs-web.com/node/38926/html, at 26.

[35] “Loyalty revenue” covers various terms used by the airlines in their 10K filings to refer to income related to the generation of loyalty, including co-branded reward cards.

[36] De Boera & Gudmundsson, supra note 21, at 22.

[37] American Airlines, supra note 35, at 37.

[38] Since most of American Airline’s primary loyalty-rewards partners are also travel-related, it seems reasonable to assume that the vast majority of partner income in 2020 was from co-branded cards.

[39] See, infra Section II.B.

[40] The first such card was an American Airlines co-branded card issued by Citibank (De Boera & Gudmundsson, supra note 21, at 19).

[41] American Airlines, 10K Filing (2022), at p. 68.

[42] United Airlines, 10K Filing (2022), at p. 41.

[43] Delta Airlines, 10K Filing (2022), at p. 37.

[44] Southwest Airlines, 10K Filing (2022), at p. 115

[45] Id at 119.

[46] Id.

[47] Jay Sorensen, Frequent Flier Credit Cards Generate More than $4 Billion for Major U.S. Airlines, Ideaworks (2008), available at https://www.ideaworkscompany.com/wp-content/uploads/2012/05/Analysis_USAirlineCC2008.pdf. See also above discussion of revenue from loyalty-rewards programs during the COVID-19 pandemic.

[48] Technically, it prohibits issuers from restricting “the number of payment card networks on which an electronic credit transaction may be processed.”

[49] See S. 1838, §2(a)(2)(A)(II): 2 or more such networks, if— (aa) each such network is owned, controlled, or otherwise operated by— (AA) affiliated persons; or (BB) networks affiliated with such issuer; or (bb) any such network is identified on the list established and updated under subparagraph (D). Subparagraph (D) empowers the Federal Reserve Board, in consultation with the secretary of the U.S. Treasury, to draw up a list of networks that pose a national security risk.

[50] See S. 1838, §2(a)(2)(A)(III): the 2 such networks that hold the 2 largest market shares with respect to the number of credit cards issued in the United States by licensed members of such networks (and enabled to be processed through such networks), as determined by the Board on the date on which the Board prescribes the regulations.

[51] S. 1838, §2(a)(2)(B).

[52] Poonkulali Thangavelu, Credit Card Market Share Statistics, Bankrate.com (Jul. 6, 2023), https://www.bankrate.com/finance/credit-cards/credit-card-market-share-statistics.

[53] S. 1838, §2(a)(2)(A)(III).

[54] S. 1838, §2(a)(2)(C).

[55] Julian Morris & Todd J. Zywicki, Regulating Routing in Payment Networks, International Center for Law & Economics, (Aug. 17, 2022), available at https://laweconcenter.org/wp-content/uploads/2022/08/Regulating-Routing-in-Payment-Networks-final.pdf.

[56] Id.

[57] American Airlines, 10-K Filing (2022), at 39.

[58] For a discussion of these, see Julian Morris, Todd J. Zywicki, & Geoffrey A. Manne, The Effects of Price Controls on Payment-Card Interchange Fees: A Review and Update, International Center For Law & Economics (Mar. 4, 2022).

[59] The multilateral “interchange fee” was developed to address circumstances where the credit-card-issuing bank was different from the merchant-acquiring bank; otherwise, it was considered an “on us” transaction. Since all three-party-card network transactions are “on us” by definition, there is no need for an interchange fee.

[60] Morris, Zywicki, & Manne, supra note 58.

[61] Reform of Credit Card Schemes in Australia: IV Final Reforms And Regulation Impact Statement, Reserve Bank Of Australia (Aug. 2002), at 13.

[62] Emily Perry & Christian Maruthiah, Banking Fees in Australia, Reserve Bank of Australia Bulletin, (Jun. 2018), available at https://www.rba.gov.au/publications/bulletin/2018/jun/pdf/banking-fees-in-australia.pdf, at 5.

[63] Iris Chan, Sophia Chong, & Stephen Mitchell, The Personal Credit Card Market in Australia: Pricing Over the Past Decade, Reserve Bank of Australia Bulletin, (Mar. 2012), available at https://www.rba.gov.au/publications/bulletin/2012/mar/pdf/bu-0312-7.pdf.

[64] See Robert Stillman, William Bishop, Kyla Malcolm, & Nicole Hildebrandt, Regulatory Intervention in the Payment Card Industry by the Reserve Bank of Australia: Analysis of the Evidence, CRA International (2008), at 16.

[65] Chan, et al., supra note 63.

[66] Companion Cards Increase Credit Card Rewards, Mozo, (Dec. 8, 2009).

[67] Designation Under the Payment Systems (Regulation) Act 1998, Designation No 1 of 2015, Reserve Bank of Australia, (Oct. 18, 2015), available at https://www.rba.gov.au/media-releases/2015/pdf/mr-15-19-designation-2015-01-american-express-companion-card.pdf.

[68] Standard No. 1 of 2016, The Setting of Interchange Fees in the Designated Credit Card Schemes and Net Payments to Issuers, Reserve Bank of Australia (May 26, 2016), amended version available at https://www.rba.gov.au/payments-and-infrastructure/review-of-card-payments-regulation/pdf/standard-no-1-of-2016-credit-card-interchange-2018-05-31.pdf.

[69] C1.3: Market Shares of Credit and Charge Card Schemes, Reserve Bank of Australia, (Sep. 2023), https://www.rba.gov.au/statistics/tables/xls/c01-3-hist.xlsx.

[70] Id.

[71] Juan Iranzo, Pascual Fernández, Gustavo Matías, & Manuel Delgado, The Effects of the Mandatory Decrease of Interchange Fees in Spain, Munich Personal Repec Archive, MPRA Paper No. 43097, (Oct. 2012), available at https://mpra.ub.uni-muenchen.de/43097/1/MPRA_%20paper_43097.pdf. at 34-37.

[72] Id. at 27. See also marginal lending-facility rates from the European Central Bank, https://sdw.ecb.europa.eu/browse.do?node=9691107.

[73] Interchange: Card Rewards Cull Takes Hold Across Europe, Loyalty Magazine (Dec. 11, 2015) https://www.loyaltymagazine.com/interchange-card-rewards-cull-takes-hold-across-europe.

[74] Interchange Fee Regulation Impact Assessment Study, Edgar Dunn & Co. (2020), at 22 (noting that, for their sample of cards with fees, annual fees rose by an average of 13% between 2014 and 2018).

[75] Table 2 does not explicitly account for inflation, but cumulative inflation from 2014 to 2018 was 1.75%. European Union Inflation Rate 1960-2023, Macrotrends (2023), https://www.macrotrends.net/countries/EUU/european-union/inflation-rate-cpi.

[76] Edgar Dunn, supra note 74, at 23.

[77] British Airways American Express® Premium Plus Card, American Express, https://www.americanexpress.com/en-gb/credit-cards/ba-premium-plus-credit-card/?linknav=en-gb-amex-cardshop-BritAirwaysAmexCC-details-learnmore-BritAirwaysPremiumPlusCC-rc (last accessed Nov. 16, 2023).

[78] Rob Burgess, What Is the Best Use of American Express Points?, Head for Points (Oct. 7, 2023), https://www.headforpoints.com/2023/10/07/what-is-the-best-use-of-american-express-points-4.

[79] See, e.g., Tara Siegel Bernard, In Retreat, Bank of America Cancels Debit Card Fee, The New York Times (Nov. 1, 2011), http://www.nytimes.com/2011/11/02/business/bank-of-america-drops-plan-for- debit-card-fee.html.

[80] Mark D. Manuszak & Krzysztof Wozniak, The Impact of Price Controls in Two-sided Markets: Evidence from US Debit Card Interchange Fee Regulation, Federal Reserve Board (Jul. 2017), https://doi.org/10.17016/FEDS.2017.074.

[81] Todd J. Zywicki, Geoffrey A. Manne, & Julian Morris, Unreasonable and Disproportionate: How the Durbin Amendment Harms Poorer Americans and Small Businesses, International Center for Law & Economics (Apr. 25, 2017), available at http://laweconcenter.org/images/articles/icle-durbin_update_2017_final.pdf; Morris, Zywicki, & Manne, supra note 58.

[82] Zhu Wang, Scarlett Schwartz, & Neil Mitchell, The Impact of the Durbin Amendment on Merchants: A Survey Study, 100(3) Economic Quarterly 183-208 (2014), at 189.

[83] Vladimir Mukharlyamov & Natasha Sarin, Price Regulation in Two-Sided Markets: Empirical Evidence from Debit Cards, Working Paper (2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3328579.

[84] Id. at 3.

[85] Id. at 3.

[86] Review of Retail Payments Regulation: Conclusions Paper, Reserve Bank of Australia (Oct. 2021), https://www.rba.gov.au/payments-and-infrastructure/review-of-retail-payments-regulation/conclusions-paper-202110/index.html.

[87] 15 U.S. Code §1693o–2(b).

[88] Regulation II (Debit Card Interchange Fees and Routing), Fed. Rsrv., https://www.federalreserve.gov/paymentsystems/regii-data-collections.htm; Consumer Price Index: All Items for the United States, Fed. Rsrv. Board of St. Louis, https://fred.stlouisfed.org/series/USACPIALLMINMEI (last accessed Aug. 10, 2022).

[89] Martha Southall, Credit Card Competition Act Could Result in Annual Savings Upward of $15 Billion, CMPSI (Jun. 7, 2023), https://cmspi.com/credit-card-competition-act-could-result-in-annual-savings-upward-of-15-billion. (CMPSI describes itself as “the go-to advisory firm for leading merchants across the globe, looking to supercharge their payments arrangements.”)

[90] S. 1838, §2(a)(2)(D)(II).

[91] Overview of EMVCo, EMVCo.com, https://www.emvco.com/about-us/overview-of-emvco (last accessed Nov. 16, 2023).

[92] For an explanation, see Morris & Zywicki, supra note 55.

[93] Anna G., Interchange Rates, CreditDonkey (Jun. 2, 2023), https://www.creditdonkey.com/interchange-rates.html. Note that these are only selections of all the available rates.

[94] H Scott Gordon, The Economic Theory of a Common-Property Resource: The Fishery, 62 J Political Econ 124 (1954).