ARNOLD PORTER LLP. Realcomp II, Ltd. ADVISORY

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1 Commitment Excellence Innovation ADVISORY NOVEMBER 2009 FTC Outlines Analytical Approach to Section 1 Rule of Reason Cases: In re Realcomp II, Ltd. The Federal Trade Commission (FTC or Commission) recently issued a unanimous opinion drafted by Commissioner Kovacic that articulated the agency s current analytical approach to rule of reason antitrust cases under Section 1 of the Sherman Act. 1 The administrative case, In re Realcomp II, Ltd., 2 was brought against Realcomp for its policies in operating a multiple listing service (MLS) for real estate in Michigan. Specifically, certain Realcomp policies governing MLS data feeds to public websites were alleged to have restrained competition in the market for residential real estate brokerage services and the market for MLS services. After an eight-day hearing including testimony and over 800 exhibits, the administrative law judge (ALJ) concluded that there was no antitrust violation. The Commission reviewed de novo and reversed the ALJ s conclusions under the rule of reason as errors of law. Alleged antitrust violations were historically treated as falling into neat categories of those condemned as illegal per se and others that must be evaluated under the rule of reason, which balances any restraints on competition with procompetitive justifications for the practice. In recent years, however, the FTC and the US Supreme Court have moved towards what they call a structured rule of reason that dispenses with the need for a full-blown competitive analysis in some circumstances where the rule of reason applies. (Officials at the Antitrust Division have also given speeches suggesting a structured rule of reason approach to analysis of resale price maintenance. 3 ) The Commission s lengthy opinion reviewed rule of reason precedent and outlined three independent avenues by which one can condemn restraints under it: (1) without proof of market power, by finding that the conduct is inherently suspect because it closely resembles conduct condemned as per se illegal; (2) without proof of market power, by finding direct evidence of an anticompetitive effect (which does not have to include involved elaborate econometric proof of resulting higher prices); or (3) by inquiring into market definition and market power and concluding that an arrangement has the potential for genuine adverse effects on competition. 4 Brussels +32 (0) Denver London +44 (0) Los Angeles New York Northern Virginia San Francisco Washington, DC This advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with competent counsel to determine applicable legal requirements in a specific fact situation Arnold & Porter LLP arnoldporter.com 1 Although the action alleges a violation of Section 5 of the FTC Act, Section 5 encompasses conduct that would violated Section 1 of the Sherman Act and the FTC stated that the analysis in its opinion under Section 5 would be the same as its analysis under Section 1 of the Sherman Act. 2 FTC Dkt. No. 9320, available at 3 See, e.g., Christine A. Varney, Dep t of Justice, Antitrust Federalism: Enhancing Federal/State Cooperation, Remarks as Prepared for the Nat l Ass n of Attorneys General (Oct. 7, 2009), available at 4 See Opinion of the Commission, In re Realcomp II, Ltd., FTC Dkt. No. 9320, at [hereinafter Realcomp Opinion], available at

2 The FTC s willingness to rely on the inherently suspect test raises questions about the threshold for proving illegal restraints and when a restraint can be sufficiently distinguished from previously condemned practices. REALCOMP S POLICIES Realcomp is an association of real estate brokers whose membership consists of half the brokers in Michigan. Realcomp s main function is the operation of its MLS, the largest in the state, which is a closed database for its broker members to share information about properties for sale and the type of agreement the listing broker has with the seller, which has implications for the applicable broker fee. The case focused on two types of listing agreements. The first was an Exclusive Right to Sell (ERTS) agreement where the buyer s broker is paid a commission based on the sale price regardless of how the buyer and seller connect. An ERTS broker is responsible for sharing his commission with the buyer s broker, but if the buyer is unrepresented, the seller s broker keeps the full commission. The second type of listing agreement at issue was an Exclusive Agency (EA) agreement, where the seller pays a low flat fee to his broker and is responsible for paying the commission of a buyer s broker but owes nothing further to his own agent if the buyer (or his agent) approaches the seller directly. EA agreements are generally used by discount brokers who unbundle listing from other services such as showing the property by appointment, holding open houses, explaining offer terms, posting a for sale sign, or assisting the seller at closing. In addition to providing the MLS to its members, Realcomp also sells some of the MLS data to websites that make MLS data available to the public. According to the allegations, Realcomp adopted several policies concerning this public data feed that limited the exposure of EA listings and restricted competition from discount brokers who generally use EA listing arrangements. One such policy was Realcomp s Website Policy, which prohibited limited service broker listings (i.e., those from discount brokers) from being transferred from the MLS to public websites. Another was Realcomp s Search Function Policy, which made the default setting on the MLS search tool include only full service broker listings and required a user to opt into a search for limited service, EA listings. The last was a Minimum Service Requirement Policy, by which Realcomp required brokers to perform a full range of services (including arranging appointments for other brokers to show a listed property, accepting and presenting offers to the seller, advising sellers on the merits of offers, assisting sellers in developing and delivering counteroffers, and participating in negotiations on behalf of sellers) before they could make ERTS listings on the MLS. This policy, in combination with the Website Policy, limited the ability of discount, limited service brokers to widely disseminate their listings. The ALJ reviewed these policies under a full-fledged rule of reason analysis and concluded that the Complaint Counsel for the FTC had not proven anticompetitive effects resulting from these policies because discount brokers could work around the restrictions and still compete effectively. The ALJ also concluded that certain defenses offered by Realcomp justified any restraint on competition imposed by the policies. On appeal, the FTC took a different approach to the application of the rule of reason and rejected the ALJ s legal conclusions. Following its reasoning in Polygram, the FTC emphasized that a full rule of reason analysis is not required in all cases: As we discussed above, not all trade restraints require the same degree of fact-gathering and analysis. Polygram, 136 F.T.C. at 327 (citing Standard Oil Co., 221 U.S. 1, 65 (1911)). Indeed, BMI, NCAA, and [Indiana Federation] indicated that the evaluation of horizontal restraints takes place along an analytical continuum in which a challenged practice is examined in the detail necessary to understand its competitive effect. Polygram, 136 F.T.C. at 336; see also California Dental, 526 U.S. at 781 ( What is required * * * is an enquiry meet for the case, looking to the circumstances, details, and logic of a restraint ). 5 The Commission concluded that Realcomp s restraints could be condemned under an inherently suspect (or 5 Id. at 20. 2

3 quick look ) analysis, but that the same result would be obtained even if a more fulsome rule of reason analysis were required. INHERENTLY SUSPECT ( QUICK LOOK ) LIABILITY Under the FTC s inherently suspect approach, conduct that is not illegal per se can nevertheless be condemned without a full rule of reason analysis under a burden-shifting regime that begins by looking to whether the conduct is inherently suspect, that is, behavior that past judicial experience and current economic learning have shown to warrant summary condemnation. 6 Conduct will be deemed inherently suspect where it closely resemble[s] 7 restraints that have been summarily condemned or where an observer with even a rudimentary understanding of economics could conclude that the arrangements in question would have an anticompetitive effect on customers and markets. 8 Where conduct is inherently suspect, it will be condemned without market analysis or proof of anticompetitive effects unless the defendants can point to cognizable and plausible efficiencies that justify their practices. 9 Only if they do so would the FTC or a court look for proof of actual anticompetitive effects. The FTC first clearly set out its inherently suspect test in Polygram (the Three Tenors case), a decision affirmed by the US Court of Appeals for the DC Circuit. 10 In that case, Polygram and Warner Communications entered into an agreement to jointly market recordings of concerts by The Three Tenors and later agreed to limit the marketing of earlier recordings by the singers to help sales of an upcoming new release. The FTC found this agreement to be a violation under a quick look standard and the DC Circuit affirmed, holding that it was misleading to consider quick look a new standard and characterizing it as just one of several ways to apply the rule of reason. In Realcomp the FTC rejected the ALJ s suggestion that courts have not widely accepted 6 Polygram Holding, Inc. v. FTC, 136 F.T.C. 310, (2003), aff d 416 F.3d 29 (D.C. Cir. 2005). 7 Realcomp Opinion, supra note 4, at California Dental Ass n v. FTC, 526 U.S. 756, 770 (1999). 9 Realcomp Opinion, supra note 4, at Polygram Holding, Inc. v. FTC, 416 F.3d 29 (D.C. Cir. 2005). use of the quick look rule of reason standard and held that it was an error not to apply it. 11 The Commission readily concluded that Realcomp s conduct was inherently suspect: In restricting the ability of the limited-service, lowercost brokers to have the same level of exposure on the increasingly popular Internet websites as the full-service brokers, it is easy to see how an observer with even a rudimentary understanding of economics could conclude that the arrangements in question would have an anticompetitive effect on customers and markets. California Dental, 526 U.S. at 770. Although not exactly the same conduct, the Realcomp Policies do bear a close family resemblance, Polygram v. FTC, 416 F.3d at 37, to conduct that courts previously have treated with acute suspicion and, at times, have condemned without an assessment of the defendant s market power, or indeed without an opportunity for the defendant to offer any mitigating justifications. 12 Explaining that other restraints on marketing and the availability of market information have been condemned previously, 13 the FTC concluded that Realcomp s policies were in essence a similar horizontal agreement among Realcomp s members to restrict participation by discount brokers. This similarity justified summary condemnation according to the FTC. Having established that Realcomp s policies were inherently suspect, the burden shifted to Realcomp to demonstrate plausible and cognizable efficiencies. Realcomp offered two justifications, arguing that the rules were necessary to eliminate two types of inefficiencies that arose from EA listings: (1) free-riding from home owners who opt to list their homes using EA listings and who then compete with 11 See Realcomp Opinion, supra note 4, at 21 n Id. at See FTC v. Indiana Federation of Dentists, 476 U.S. 447, 458 (1986) (condemning agreement to deny insurers information about patient x-rays); Denny s Marina, Inc. v. Renfro Productions, Inc., 8 F.3d 1217, (7th Cir. 1993) (condemning concerted action to exclude competitor from trade shows); Detroit Auto Dealers Ass n v. FTC, 955 F.2d 457 (6th Cir.1992) (condemning dealers agreement to restrict show room hours). 3

4 cooperating brokers to find buyers for their home; and (2) a bidding disadvantage faced by buyers who use cooperating brokers when bidding against an unrepresented buyer for a home listed under an EA agreement. 14 The Commission rejected both of these justifications. With respect to the free riding justification, the Commission held that there was nothing free about discount brokers or their clients use of the MLS data feed to promote EA listings in which the home owner would compete with brokers to sell his own home because a home could only be listed on the MLS through a member broker. That broker in turn pays dues to Realcomp to support the operation of the MLS. Because Realcomp makes the same amount of money from an EA listing as an ERTS listing, there was no free riding. And listing brokers who place an EA listing for a small fee instead of a commission or lose the listing because they offered a full-fledged ERTS listing that was rejected by the homeowner are not losing money through free-riding; they are losing money through competition. 15 The free riding justification for the website listing policy was completely without merit because the rationale was not to ensure the continued efforts of cooperating brokers, but to reduce price pressure on commissions. 16 Realcomp also asserted that its policies were justified to correct a bidding disadvantage faced by brokers representing buyers bidding on an EA listing. Realcomp asserted that EA sellers have a preference for an unrepresented buyer because then they will not have to pay commission to the buyer s broker. ERTS sellers, on the other hand, lack such a preference because they pay a fixed percentage regardless of whether the buyer has a broker or not. The FTC rejected this justification because all it did was prop up a commission structure that raises the cost of selling a home without any increase in output or quality. According to the FTC, policies that correct for such an alleged disadvantage merely keep prices from falling below a de facto floor created by the ERTS fee system and are not cognizable under the antitrust laws. 14 Realcomp Opinion, supra note 4, at Id. at Id. at 32. Having failed to offer a plausible, cognizable efficiency justification, Realcomp s policies violated Section 1 and Section 5 under the Commission s inherently suspect analysis. MORE TRADITIONAL EFFECTS AND MARKET POWER APPROACHES The FTC s opinion also went through the exercise of evaluating Realcomp s policies under the more traditional rule of reason models to bolster its finding of illegality. It looked for evidence of actual anticompetitive effects and conducted a traditional rule of reason analysis that applies a market power threshold screen and then looks to whether the conduct at issue is anticompetitive. 17 Unlike the ALJ, the FTC found the regression model of Complaint Counsel s economist to be convincing and sufficient direct proof of actual anticompetitive effects because it showed a correlation between the implementation of Realcomp s policies and a decline in the number of EA listings. According to the economist, the policies reduced consumer choice for brokerage services and protected the de facto price floor for full-service brokers operating on commission. Based on these findings, the FTC concluded that the policies were an unlawful restraint on competition without further inquiry into market power. The FTC continued and performed the final rule of reason analysis, which requires finding of market power and conduct with a potential for anticompetitive effects. Since Realcomp had acknowledged it possessed market power, the analysis was straightforward. The FTC held that the policies were facially restrictive in nature by limiting customer access to limited service broker listings, limiting the reach of those listing through the Search Policy, and reducing downward price pressure on the full-service brokers who are largely compensated on commission See generally Tops Markets, Inc. v. Quality Markets, Inc., 142 F.3d 90, 96 (2d Cir. 1998) (plaintiff has two independent means by which to satisfy the adverse-effect requirement direct proof of actual adverse effect on competition or indirectly by establishing sufficient market power to cause an adverse effect on competition ). 18 Id. at 37. 4

5 The FTC rejected the ALJ s conclusions that the restraints were reasonable, in part, because they did not completely exclude discount brokers, holding that [t]he relevant question, however, is not whether Realcomp s Policies completely excluded discount brokers from advertising their listings on the MLS, but whether they tended to stifle competition. The Policies did so. 19 For example, Realcomp MLS users viewed residential and condominium ERTS listings on average a total of 201 times per month compared to only 94 times per month for such EA listings, and Realcomp MLS users ed residential and condominium ERTS listings on average a total of 286 times per month compared with EA listings who were ed an average of one time per month less than 0.4 percent as often. 20 CONCLUSION The FTC s decision in Realcomp demonstrates the Commission s continued interest in pursuing concerted conduct that is not illegal per se under the inherently suspect or quick look rubric. It also demonstrates a continuation of the FTC s trend of reversing decisions by ALJs finding that the Commission had failed to prove its case, though here the disagreement with the ALJ was primarily on the law, not the facts (which the Commission has the power to review de novo). conclusions. Thus, despite the position in Realcomp that each mode of rule of reason analysis can stand on its own, it remains to be seen whether the Commission will pursue cases as inherently suspect where consumer harm or market power are far from clear. The Commission s decision to show how it should prevail regardless of the mode of rule of reason analysis may reflect not a lack of confidence in the inherently suspect test which has been upheld by the courts so much as a desire to reassure firms and the antitrust community that the Commission will not apply the test simply to win cases it would otherwise lose. If you would like more information about any of the matters discussed in this advisory, please contact your Arnold & Porter attorney or: Jonathan Gleklen Jonathan.Gleklen@aporter.com Justin P. Hedge Justin.Hedge@aporter.com Proving a full-fledged rule of reason case is hard, though in this case it was made easier by Realcomp s concession that it had market power in the relevant market. Use of the inherently suspect mode affords the Commission a shortcut by which it can avoid the challenges inherent in defining and proving a relevant market and market power, or proving actual competitive effects. Notwithstanding its endorsement of the inherently suspect shortcut in rule of reason cases, however, the FTC continues to buttress its inherently suspect analysis by showing that the same results obtain under a more fulsome rule of reason analysis. In both Realcomp and Polygram the FTC found liability under the inherently suspect test but nevertheless continued to analyze and make findings on the presence of direct anticompetitive effects to further support its 19 Id. at Id. 5