On May 8, a Federal Trade Commission Administrative Law Judge rejected FTC complaint counsel’s allegations that McWane, Inc., a manufacturer of waterworks products, had engaged in price-fixing and unlawful information exchange. The FTC prevailed, however, on claims that McWane engaged in exclusionary conduct.1 To remedy the violations, Judge Chappell entered an order that forbids McWane from conditioning product availability or purchase terms on a customer’s promise of exclusivity. The order also strictly limits the types of rebates and discounts that McWane may offer.

Price-Fixing / Conspiracy

The FTC alleged that McWane and its two main competitors, Sigma and Star, conspired to raise and stabilize prices in the market for ductile iron pipe fittings. Specifically, the FTC alleged that the three suppliers agreed to curtail their prior practice of offering discounts on the published fittings prices.2 Judge Chappell ultimately concluded that the FTC could not meet its burden to show an illegal agreement because the circumstantial evidence presented to the court was at least as consistent with independent action. Particularly in the context of an oligopolistic market, Judge Chappell noted, a theory that depends on “numerous assertions, assumptions, and inferences that are not sufficiently grounded in evidence” will not suffice to prove agreement.3

While some conspiracies can be shown through direct evidence (such as recordings of price fixing meetings), conspiracies are usually proven with circumstantial evidence, which consists of “economic evidence suggesting that the defendants were not in fact competing, and noneconomic evidence suggesting that they were not competing because they had agreed not to compete.”4 However, the government’s burden to prove an agreement is not met where the circumstantial evidence is equally consistent with independent action.5 Judge Chappell emphasized that in an oligopolistic market such as this one, firms are inherently interdependent, but interdependent decisions may still be arrived at independently.6 Thus, the “analytical challenge when evaluating an alleged conspiracy in an oligopolistic market … is to distinguish between mere tacit collusion, on the one hand, which is a function of interdependence, and is not unlawful, and an agreement.”7

The FTC attempted to demonstrate the existence of an agreement by proving certain plus factors.8 Although there is “no exhaustive list of ‘plus’ factors,” there are three general categories: evidence of motive to enter into a price-fixing conspiracy, evidence that the defendant acted contrary to self-interest, and evidence indicating an actual agreement.9 Judge Chappell explained that the first two categories are not particularly probative in the oligopolistic setting, since they “typically only demonstrate interdependence among the oligopolists.”10 The Judge rejected the FTC’s other proffered plus factors as factually unsupported.11 After a detailed analysis of the documents relied upon by the FTC, he determined that they either failed to implicate McWane, as opposed to the other two suppliers; “require multiple, unsupported inferences to implicate McWane”; are inconsistent with the existence of an agreement; or are “at least as consistent with independent, or merely interdependent, conduct.”12 He reasoned that, “[a]t best, the evidence shows interdependent or consciously parallel conduct, unaided by agreement, which is not illegal.”13 Judge Chappell repeatedly emphasized that the government cannot meet its burden with evidence that is just as consistent with independent action as it is with agreement.14

Judge Chappell further concluded that “the preponderance of the economic evidence is not consistent with the alleged conspiracy.”15 The FTC did not proffer its own economic expert, and the “indirect and inferential economic evidence” it relied upon was not persuasive.16 The Judge instead credited McWane’s economic expert, who concluded that the economic data was not consistent with the alleged price-fixing conspiracy.17 Based on invoice data, the expert determined that McWane’s prices actually declined over the relevant period, even in the face of rising input costs.18 He concluded that the pricing pattern was “more consistent with competitive, independent decision-making by McWane than with concerted action.”19 The expert also explained that an agreement to curtail discounting would be reflected in a decrease in price variance, but the data showed no such decrease.20 Furthermore, McWane’s expert determined that the inventory data contradicted any suggestion of quantity withholding, which would facilitate a cartel’s ability to raise prices.21 The Judge found that the expert’s conclusions “constitute substantial, probative, economic evidence that is not consistent with an inference of conspiracy.”22 Having concluded that the totality of the evidence failed to prove the alleged conspiracy, Judge Chappell dismissed the pricefixing charge against McWane.23

Monopoly Power / Exclusionary Conduct

Judge Chappell did, however, conclude that the FTC provided sufficient evidence that McWane had monopolized the narrower market for domestic ductile iron pipe fittings and had illegally sought to maintain this monopoly through exclusionary conduct that constituted an unfair method of competition. The FTC asserted that McWane eliminated Sigma as a potential market entrant by entering into an exclusive distribution agreement with Sigma, allowing Sigma to share in McWane’s monopoly profits.24 The Commission also asserted that McWane used exclusive dealing policies to exclude Star from the market.25

Judge Chappell analyzed the distribution agreement with Sigma under the rule of reason and determined that it was anticompetitive.26 McWane entered into the agreement because it feared Sigma would otherwise enter the market,27 and the agreement contained “restrictive terms that were not necessary for McWane to sell Domestic Fittings to Sigma.”28 Specifically, the agreement required Sigma to purchase domestic fittings only from McWane and to stop efforts to produce its own domestic fittings, and the agreement effectively set the prices Sigma could charge.29 Judge Chappell rejected both of McWane’s proffered procompetitive justifications.30 McWane had argued that the distribution agreement was part of an effort to keep sufficient volume to support its last U.S. foundry, but the Judge explained that a desire to increase sales is not a valid justification for exclusionary conduct, and that, at any rate, McWane had not expected the distribution agreement to actually increase the size of the market.31 The Judge determined that McWane’s other proffered justification – that Sigma could reach and service customers that McWane could not – could not be used to justify the distribution agreement’s restrictive provisions, as the restrictions were not themselves reasonably necessary to achieve the stated objective.32 Because the restrictions in the distribution agreement lacked any procompetitive justification, Judge Chappell declared it an unreasonable restraint of trade.33

Judge Chappell also found the evidence sufficient to show that McWane had pressured distributors to enter into exclusive dealing arrangements in order to exclude Star from the market. The initial decision explains that McWane had always had rebate programs that gave customers a retroactive percentage discount on their previously completed purchases, the amount of which was based on their annual purchases from McWane.34 In September 2009, McWane announced a new policy called the Full Support Program, under which customers were told that they must buy all of their domestic fittings requirements from McWane or its exclusive distributors (unless the product was not readily available) or risk the loss of accrued rebates and/or a shipping delay of up to twelve weeks.35 Most customers understood this to mean that buying from Star would result in losing access to McWane’s products and losing their McWane rebates,36 and McWane did in fact withhold a rebate from and refuse to sell to one customer who purchased domestic fittings from Star.37

Judge Chappell characterized the Full Support Program as “an all-or-nothing exclusive dealing arrangement.”38 His decision notes that after McWane announced the policy change, “numerous Distributors pulled their requests for quotes, cancelled orders, or decided not to purchase Domestic Fittings from Star,”39 and that most distributors “acceded to heavy economic pressure and, with minor exceptions, purchased all their Domestic Fittings from McWane.”40 Because Star did not yet offer a full line of domestic fittings, customers could not afford to risk losing access to McWane’s products.41 The Judge concluded that the Full Support Program significantly foreclosed the domestic market to potential competitors such as Star and thus constituted unlawful exclusionary conduct.42

To remedy these violations, Judge Chappell entered an order that prohibits McWane from entering into any agreement with competitors to allocate or divide markets or customers, or from monopolizing or attempting to monopolize the market for domestic ductile iron pipe fittings.43 The order prohibits McWane from imposing any conditions designed to induce customers to buy domestic fittings exclusively from McWane or to refrain from buying from McWane’s competitors.44 Specifically, McWane may not require exclusivity as a condition of selling to a customer, nor may McWane condition the price or speed of filling orders on a customer’s exclusivity.45 McWane is expressly prohibited from conditioning the price or service afforded to a customer on that customer buying at least half of its domestic fittings requirements from McWane.46 The order also forbids McWane from penalizing or retaliating against a customer for purchasing from a competitor.47

The order also places restrictions on the types of discounts and rebates McWane may offer with respect to its sales of domestic fittings. For ten years, McWane is prohibited from offering any type of retroactive incentive,48 which includes (i) a lump-sum rebate based on the customer’s purchases reaching a specified threshold or (ii) any discount on the price of prior units that is based on the purchase of additional units.49 However, McWane is explicitly permitted to offer volume-based discounts that apply only to the units that exceed a specified threshold.50 The company may also provide a rebate so long as it is not conditioned on purchases reaching a particular threshold.51

Appeals

McWane plans to appeal the four counts on which the Judge sided with the FTC.52 The company has stated that Judge Chappell’s findings of unfair competition based on the implementation of its rebate program are contrary to established precedent.53 The FTC has not yet indicated whether it will appeal the three counts that Judge Chappell dismissed.

Implications

The McWane decision does not break new ground regarding the analysis of circumstantial evidence of collusion. Rather, it is consistent with the Supreme Court’s decisions in Twombly 54 and Matsushita 55 precluding an inference of unlawful collusion from circumstantial evidence of market behavior that is equally consistent with unilateral action. Several important points can be drawn from Judge Chappell’s reasoning and conclusions regarding exclusionary conduct. As the opinion notes, monopoly power in the market did not necessarily mean that McWane’s conduct was anticompetitive. Rather, the focus of the analysis was whether McWane, as a monopolist, could, and did, exclude its competitors from the market through anticompetitive tactics.

With regard to the distribution agreement between McWane and Sigma, Judge Chappell observed that the agreement contained unnecessary and restrictive terms that served no purpose other than to keep Sigma from entering the market as a competitor. Although reaching new customers or increasing the efficiency of distribution may potentially serve legitimate procompetitive purposes, under a rule of reason analysis, such goals may not be used to justify restrictions that are not reasonably necessary to achieve those objectives.

In finding that McWane engaged in exclusionary conduct, Judge Chappell looked to the “all or nothing” nature of the Full Support Program. As a condition to maintaining a supplier relationship with its customers, McWane demanded exclusivity. This exclusivity was imposed through conditioning customers’ rebates on an agreement not to use another supplier and threatening to penalize them if they purchased product from another company. These types of restrictive financial terms and delays in providing products amounted to de facto exclusivity in that customers were deprived of the choice as to which company to do business with. This type of exclusivity, Judge Chappell concluded, amounted to illegal exclusionary conduct. Exclusive dealing may be viewed as procompetitive if there is no significant adverse effect on competition, or if a sufficient business justification outweighs the potential harm to competition. While these types of arrangements require fact-specific analysis, key factors to consider are (i) whether the exclusionary aspects of an arrangement are necessary to achieve the procompetitive benefits articulated and (ii) whether those benefits actually have a positive impact on consumers.

Finally, the McWane decision reflects the FTC’s hostility to loyalty rebate schemes and other conduct that promote de facto exclusivity when undertaken by firms with high market shares. The FTC’s consent decree with Intel56 contains similar provisions prohibiting Intel from conditioning benefits to customers on promises that the customers will only purchase products from Intel, and specifically prevents Intel from using certain discounting structures (such as lump sum discounts available if customers reach certain purchase levels and so-called “all units” discounts that apply to all units once purchases reach a given threshold). The FTC’s consent decree with Transitions Optical57 likewise banned agreements conditioning discounts on its customers’ agreement to limit the business they did with Transitions’ competitors or on the share of business they gave to Transitions and prohibited Transitions from using “all units” discount structures. And in a recent speech, newlyconfirmed FTC Commissioner Josh Wright likewise urged that loyalty discounts, including those involving all units discount structures, should be analyzed under an exclusive dealing rubric, rather than treated as pricing conduct that cannot be deemed unlawful unless the price is below cost.58