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 interlocutory appeal 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.

The facts. LinkLine is an internet service provider (ISP) that sells its customers DSL access. It purchases wholesale DSL services 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 services to ISPs. AT&T is vertically integrated and also sells DSL access 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. It is the classic price squeeze allegation first formulated 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. (Here is another point that is not developed factually because of the early grant of cert: to what extent are prices for whole sale DSL services and retail DSL access + ISP services comparable?)

Depending on how you look at it, the problem is either that AT&T’s wholesale rate is too high, or that its 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 AT&T’s 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 had become broader:

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 Reach of Trinko. The Ninth Circuit, in an elegantly reasoned opinion (pdf), argued that Trinko does not preclude liability. The Trinko decision of course is a bit schizophrenic in its treatment of antitrust in regulated industries. Trinko first acknowledges that the Telecommunications Act explicitly does not replace antitrust liability: “[N]othing in this Act … shall be construed to modify, impair, or supersede the applicability of any of the antitrust laws.” 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: (1) The claim in Trinko was novel while the TelCo Act did not contemplate an expansion of antitrust liability, and (2) the presence of a regulatory structure designed to deter and remedy anti-competitive harm and the cost of false positives flowing from enforcing §2 counsel against expanding the reach of §2. Applying this test, the Ninth Circuit found that a price-squeeze claim is a traditional antitrust theory of liability going back to Alcoa (thus does not require an expansion of antitrust liability), and that the regulatory structure at work in the LinkLine case is not “designed to deter and remedy anti-competitive harm” of the price-squeeze kind, because the regulation 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 and that it is the regulator’s duty to make sure that regulated wholesale price is low enough not to enable the vertically-integrated monopolist to use a price squeeze. This approach is problematic: The LinkLine case shows that price regulation at only the wholesale level provides an opportunity for the vertically-integrated monopolist to distort competition to the detriment of its competitors, whose costs it at least partially controls. 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 salutary effect on the behavior of vertically-integrated monopolists?

The Price Squeeze. The second issue is the price squeeze. The theory flows from United States v. Aluminum Co. of America [Alcoa] (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 are problematic. 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.

The duty to deal is also the point of departure for the DoJ in its 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 impair or supersede) ignores the regulatory duty to deal, and the TelCo Act regulation doesn’t address the price squeeze because it reaches only the wholesale level, the public policy underlying the TelCo Act is undermined. The mandate that there be competition with the ILECs has lost its teeth.

The conclusion reached by the DoJ is that price squeezes, absent (antitrust) duty to deal at the wholesale level, can’t state a claim. (And it doesn’t help that the Ninth Circuit was unable to formulate a really practicable test for a price-squeeze claim, withdrawing instead to an intent requirement “so serve monopolistic purposes” drawn from the Ninth Circuit’s City of Anaheim decision.) According to the DoJ, price-squeeze theories boil down to a claim that retail pricing is so low as to harm competition. Antitrust liability for price squeezes is therefore 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), since it only compares retail prices with some measure of cost of the monopolist—it is blind to the wholesale level. 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. In other words, the risk of false positives is particularly high where liability is based on prices that are allegedly too low. The tough standard is much less justified if, as in the price-squeeze cases, the defendant monopolist 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. This fact diminishes significantly the concern of false positives. A tough standard for predatory pricing is justified where there is a danger of protecting the less-efficient competitor. It is much less justified where it is in the power of the low-price vertically-integrated monopolist to raise the cost of its retail competitors.

Update: The American Antitrust Institute, a private think tank that filed an amicus brief in LinkLine,  has been given time at oral argument. It is highly unusual or even unprecedented for public-interest organizations to be given oral argument time in antitrust cases, although the state AGs have appeared in oral argument before (for example in State Oil v. Khan and Leegin). HT to the AT-CONVERSATION listserve.

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