Corporate & Securities Law

Thoughts on LinkLine

By Manfred Gabriel

The Supreme Court will hear oral arguments in the case of Pacific Bell Telephone Company v. LinkLine Communications, Inc. on December 8th. (Briefs can be found here.) The court rushed to grant cert on a case that is on appeals from a 12(b)(6) motion; the facts haven?t been fully developed, leaving (for example) the question of market definition open?do DSL services compete with satellite and cable? I predict that the Supreme Court will regard the case as an opportunity to extend the reach of Brooke Group, thereby further limiting Section 2 liability and abolishing price squeezes as a theory of liability, and to reinforce the message in Trinko that antitrust law takes a backseat to regulation, even imperfect regulation.

First, the facts. LinkLine is an internet service provider (ISP), which sells its customers DSL access. It purchases wholesale DSL access from AT&T California (formerly SBC, formerly Pacific Bell), which is the incumbent local exchange carrier (or ILEC) and required under the Telecommunications Act to provide wholesale DSL access to ISPs. AT&T is vertically integrated and also sells DSL services and ISP services at retail. LinkLine claims that the difference between the price at which AT&T sells wholesale DSL services and the price of AT&T?s retail DSL/ISP is such that LinkLine cannot compete at retail with AT&T. This is the classic price squeeze allegation first formulated by in Alcoa. The (so far uncontested) allegation is that at times AT&T?s retail price was below the wholesale price for DSL access charged to LinkLine.

Depending on how you look at it, the problem is either that AT&T?s wholesale rate is too high, or that the retail price is too low. The wholesale price is subject to regulation and regulatory oversight. The retail price isn?t; but a retail DSL price that is too low points to a Brooke Group-style predatory pricing claim. The District court, granting leave to file an interlocutory appeal from its denial of the 12(b)(6) motion, certified the following question to the Ninth Circuit:

?The issue before the Ninth Circuit will not be whether Trinko bars price-squeeze claims generally but, more specifically, whether it bars predatory price-squeeze claims (i.e., price-squeeze claims which comply with the Brooke Group requirements).?

The Ninth Circuit affirmed. By the time the Supreme Court granted cert (the Solicitor General was in favor, the FTC opposed), the issue became this:

Whether a plaintiff states a claim under § 2 of the Sherman Act by alleging that the defendant?a vertically integrated retail competitor with an alleged monopoly at the wholesale level but no antitrust duty to provide the wholesale input to competitors?engaged in a ?price squeeze? by leaving insufficient margin between wholesale and retail prices to allow the plaintiff to compete.

The case raise two issues: Should there be a price squeeze theory of liability under §2? And does Trinko preclude liability in this case because there is regulation in place that controls the wholesale price AT&T can charge as the ILEC?

The Ninth Circuit, in an elegantly reasoned opinion (pdf), argued that Trinko does not preclude liability. It is well known that the Trinko decision is a bit schizophrenic since it first acknowledges the fact that the Telecommunications Act explicitly does not replace antitrust liability. By the end of the Trinko decision, however, the Supreme Court holds that antitrust liability is precluded by the existence of regulation, for two reasons: The claim in Trinko was novel and the TelCo Act did not contemplate an expansion (or preemption) of antitrust liability, and the presence of a regulatory structure designed to deter and remedy anti-competitive harm together with the cost of false positives counsels against expanding the reach of §2. Applying this test, the Ninth Circuit finds that a price-squeeze claim is a traditional antitrust theory of liability going back to Alcoa, and that the regulatory structure at work in the LinkLine case is not ?designed to deter and remedy anti-competitive harm? because it operates only on wholesale level but not on the retail level. Here is a graphic summary of the argument:

While I am sympathetic to the Ninth Circuit?s argument, I doubt that the Supreme Court will buy it. It?s an antitrust commonplace these days that putting courts in the position of setting or approving prices is a bad idea. This will be grounds enough for the Supreme Court to further tighten the Trinko holding, I believe: the Court will hold that even incomplete regulation precludes antitrust liability. This approach makes me uneasy. The LinkLine case shows that price regulation at only one level (wholesale or retail) provides an opportunity for the vertically-integrated competitor to distort competition to the detriment of its competitors, whose costs it controls, at least partially. That is not to say that I am entirely comfortable with a court imposing §2 liability here. I also would rather avoid thrusting the courts in a position of approving prices. But wouldn?t the threat of §2 liability, even imperfectly administered, have a salutory effect on the behavior of vertically-integrated monopolists?

The second issue is the price squeeze. The theory flows from United States v. Aluminum Co. of America (1945) and Town of Concord v. Boston Edison Co. (1990). Judge Learned Hand in Alcoa identified four elements of a price squeeze claim: (1) monopoly power; (2) the monopolist charges a wholesale price that is higher than a ?fair price;? (3) the monopolist competes downstream (that is, is vertically-integrated); and (4) the monopolist?s downstream or retail price is so low that competitors cannot match it and still earn ?a living profit.? Two things about this test make me shudder. First, the thought that courts will need to adjudicate what a ?fair? wholesale price is, and second that the Alcoa test is not connected to the question whether the monopolist has a duty to deal with its competitors. It seems obvious that, if the monopolist has no duty to deal at all with a (downstream) competitor, it cannot have a duty to deal at a particular price if it chooses to sell to the downstream competition. Charging “high” wholesale prices is economically equivalent to an outright refusal to deal, and it should not lead to liability absent a duty to deal at the wholesale level.

This is the point of departure for the DoJ in it?s brief favoring reversal of the Ninth Circuit: AT&T had no antitrust duty to deal with LinkLine. True, there was a regulatory duty to deal under the TelCo Act, but since that wasn?t an antitrust duty to deal, it should be ignored and the case decided as if there were no duty to deal at all, according to the DoJ. This line of reasoning has a certain logical elegance, and it builds on some previous cases (like Covad), but it isn?t satisfying. The TelCo Act, after all, created the system of ILECs and CLECs and duties to deal in order to create competition with the ILECs. If antitrust law (which the TelCo Act by its own terms did not preempt) ignores the regulatory duty to deal, and the TelCo Act regulation doesn’t address the price squeeze, the public policy underlying the TelCo Act is undermined.

The conclusion reached by the DoJ is that price squeezes, absent (antitrust) duty to deal at the wholesale level, can’t state a claim. Such theories boil down to a claim that retail pricing is so low as to harm competition. Antitrust liability for price squeezes is justified only, according to the DoJ, if the Brooke Group standard for predatory pricing is met. This in effect abolishes the price squeeze as a theory of antitrust liability, because no additional elements of the squeeze are necessary if prices are below cost and there is a prospect of recoupment.

But I have my doubts that Brooke Group fits in these situations: on the one hand, the predatory pricing test ignores the existence of a regulatory duty to deal (as I’ve discussed). On the other, the Brooke Group standard, with its recoupment test is particularly tough to meet. This toughness is generally justified because antitrust law should be wary of enforcing higher prices; low prices prima facie enhance consumer welfare. The tough standard is much less justified if, as in the price squeeze cases, the defendant controls the cost of a significant input of its competitors. In LinkLine, AT&T controls the price of DSL wholesale services, which we can assume will make up the largest item in LinkLine?s cost of delivering DSL retail services. A tough standard for predatory pricing is justified where there is a danger of protecting the less-efficient competitor. They are much less justified where it is in the power of the low-price vertically-integrated competitor to raise the cost of its retail competitors.

Full post as published by Antitrust Review on November 19, 2008 (boomark / email).