A Book on Books: SDNY Issues 160-Page Opinion Declaring that Apple Violated Section 1 of the Sherman Act by Conspiring to Raise E-Book Prices

by Mintz Levin

On July 10, 2013, 15 months after the Department of Justice (DOJ) filed its suit against Apple Inc. (Apple) and five major publishers for allegedly conspiring to raise e-book prices and end e-book retailers’ freedom to compete on price, Judge Denise L. Cote of the Southern District of New York found that Apple violated Section 1 of the Sherman Act. United States v. Apple Inc., No. 12 Civ. 2826 (S.D.N.Y. July 10, 2013). All five publishers have settled with the DOJ, with the final settlement pending court approval. Apple intends to pursue an appeal of the decision, and as a result there may be more to come in the case. However, the decision itself is worth discussion (even though it is largely fact-driven).

Following a three-week bench trial, Judge Cote issued a 160-page opinion, relying primarily on documents rather than testimony, in which she found that Apple masterminded a horizontal conspiracy among the publishers to raise e-book prices. Judge Cote essentially determined that the documents in the case spoke for themselves and that Apple and the publishers “were less than forthcoming” and could not explain away the “contemporaneous documentary record [that] was replete with admissions about their scheme.” The publishers’ prior attempts to raise e-book prices had been unsuccessful, and Apple’s participation was critical to their success in raising e-book prices.

The Court found that Apple did not want to compete on e-book prices with Amazon or any other e-book retailer. Apple entered its negotiations with the publishers knowing that the publishers were frustrated with Amazon’s “wretched” $9.99 price point, were eager to raise revenue, and were fearful that Amazon would retaliate against them if pushed for higher prices or would try to go around them by negotiating directly with authors and agents. Apple, according to Judge Cote, on the verge of its 2010 iPad and iBookstore releases, “brilliantly played its hand[,]” taking advantage of the publishers’ frustration and providing the publishers with the vision, format, timetable, and coordination to raise e-book prices.

Apple convinced the publishers to force Amazon and other retailers to switch from a wholesale model, in which the retailers set their own prices, to an agency model. Under the agency model, retailers act as agents for the publishers, thereby allowing the publishers to set retail prices. This shift was reinforced by Apple’s agreements with the publishers which contained most favored nation (MFN) clauses. The MFN clauses guaranteed that Apple would be allowed to match the lowest retail price on any competitor’s e-bookstore and imposed severe financial penalties on publishers if they failed to comply. Accordingly, the MFNs forced the publishers to move all of their retailers to an agency model.

Judge Cote further determined that Apple served as a critical part of the e-book price-raising conspiracy. Without Apple’s coordination and communication with each publisher, promising to each that the others would be subject to identical terms, and keeping them all appraised of what the others were doing, Amazon could have withstood the pressure or retaliated against the publishers. The Court stressed the fact that both Apple and the publishers stated that it was unlikely that any publisher could have unilaterally forced Amazon to switch to the agency model. Apple therefore facilitated a conspiracy with the publishers to eliminate retail price competition. As a result of Apple’s actions and these agreements, the Court found that e-book prices shifted upwards an average of 18% and in some cases, as much as 50%.

The Court rejected each of Apple’s defenses and evidentiary interpretations. First, the Court rejected Apple’s argument that the evidence did not “tend to exclude” the possibility that Apple acted consistent with its lawful business interests. Relying on Monsanto Co. v. Spray-Rite Svc. Corp., 465 U.S. 752 (1984), Apple argued that when evidence is ambiguous, a fact-finder may only find the defendant liable if it concludes that participation in the conspiracy is “the more likely explanation” for the conduct. The Court, however, found no ambiguity in the evidence and rejected Apple’s interpretation of Monsanto, noting that the Second Circuit has explicitly stated that “conspiracy must be a reasonable inference that the [fact-finder] could draw from that evidence; it need not be the sole inference.”

The Court also disagreed that Apple engaged in reasonable business practices because its agreements contained no illegal provisions. While the DOJ did not argue, and the Court did not find, that either agency agreements or MFN clauses are inherently illegal, the Court found that the unambiguous facts and circumstances surrounding them rendered them an unreasonable restraint of trade.

Second, the Court rejected Apple’s argument that it never intended to conspire with the publishers and that it was the publishers who raised the prices. Instead, Judge Cote found that the evidence overwhelmingly supported the position “that Apple knew of the unlawful aims of the conspiracy and joined that conspiracy with the specific intent to help it succeed.” Apple similarly attempted to argue that its negotiations with the publishers were contentious, but the Court dismissed that argument, instead citing to Seventh Circuit case law holding that “[t]he need to negotiate some details of the conspiracy… does not strip a defendant of the organizer role.”

Third, Apple argued that the DOJ failed to demonstrate increased prices because, absent Apple’s market entry and the switch to the agency model, the publishers would have withheld e-books and there would have been no established $9.99 price to raise. Judge Cote rejected this argument, finding that there was no evidence that the publishers’ withholding of e-books would have been widespread, long-lasting, or effective.

Fourth, the Court disagreed with Apple’s interpretation of the trial record as demonstrating that Apple acted independently and as a lawful participant in negotiations typical of new market entrants. Rather, the judge determined that the DOJ’s reading of the evidence is consistent with the documents, and Apple ignored or stretched much of the evidence.

Fifth, the Court rejected Apple’s argument that its conduct should be analyzed under the rule of reason because it is neither a horizontal player nor a dominant participant in a hub and spoke conspiracy. The Court disagreed, instead finding that Apple directly participated in the horizontal price-fixing conspiracy, and the fact that it was not dominant did not negate the applicability of the hub and spoke conspiracy model.

Finally, the Court rejected the argument that a verdict against Apple would discourage businesses from entering concentrated markets and stifle innovation. Despite taking the argument seriously — as the antitrust laws are intended to protect competition and not competitors — the Court did not find it persuasive.

Immediately following the opinion’s release, the DOJ issued a statement declaring the result a victory for consumers and emphasizing that “[c]ompanies cannot ignore the antitrust laws when they believe it is in their economic self-interest to do so.”

The Court has yet to set a damages trial date. Apple still maintains that it did nothing wrong and has already announced its plan to appeal.

It is worthwhile to emphasize two points arising from the decision. First, while MFN clauses are common in many industries, the DOJ has long expressed concern that such clauses may have anticompetitive consequences. Although the DOJ also concedes that MFNs frequently do not have competitive consequences, this decision, particularly if affirmed, suggests that companies would be wise to proceed judiciously in using MFNs, and to obtain legal counseling before insisting upon them.

Second, the antitrust laws are based upon the basic tenet of unilateral decision making. There is an understandable concern by many companies not to take a provocative step unless they feel that competitors will follow. It was that dynamic that led to what the court found to be a “conspiracy.” The fact that the target was Amazon, the “800 pound gorilla,” did not excuse the activity of the publishers and of Apple from antitrust condemnation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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