Second Circuit Affirms District Court Ruling Against Apple in E-Books Price-Fixing Suit, Creating Potential Circuit Split

By Victoria Jeffries, Scott Sher, Jonathan Jacobson
Wilson Sonsini Goodrich & Rosati
Jul 2, 2015

On June 30, 2015, in a 2-to-1 ruling, the Second Circuit affirmed the district court's judgment in United States v. Apple, Inc.1 that Apple and five of the largest book publishers in the U.S. entered into a per se illegal price-fixing scheme in violation of Section 1 of the Sherman Antitrust Act. In April 2012, the Department of Justice, joined by 33 states, filed suit against Apple for orchestrating a hub-and-spoke conspiracy intended to extinguish price competition among e-book retailers and for increasing retail e-book prices by an average of 24 to 40 percent.

Hub-and-Spoke Conspiracy: Apple and the Defendant Publishers' Scheme

Beginning in 2009, in the run-up to launching its new iPad in April 2010, Apple designed and executed upon a scheme with five of the six largest book publishers in the U.S.2 to fix prices for e-books and extinguish retail competition for the same. In late 2009, Amazon enjoyed a 90 percent share of U.S. e-book sales. It engaged in a loss-leader pricing practice of selling New York Times bestsellers and other new books for $9.99 to entice new customers. The defendant publishers feared that Amazon's practice—which priced some of the publishers' most in-demand books near or below their wholesale price—put downward pricing pressure on the publishers' pricing for paper books. As the district court found, "Apple understood that the Publishers wanted to pressure Amazon to raise the $9.99 price point for e-books, that the Publishers were searching for ways to do that, and that they were willing to coordinate their efforts to achieve that goal."3

Apple, for its part, was determined to make a profit on e-books sold through the iPad. At a launch event for the new tablet, Apple CEO Steve Jobs was asked why anyone would buy Apple's e-books for $14.99 when Amazon and Barnes & Noble were selling e-books for $9.99. As the Second Circuit wrote, Jobs "confidently" responded, "that won't be the case . . . the price will be the same. . . . Publishers will actually withhold their [e]books from Amazon . . . because they are not happy with the price."4 Apple's solution was to upend the long-established wholesale model in the publishing industry by employing a so-called "agency model." Under the agency model, the defendant publishers coordinated with each other and Apple to determine e-book retail prices that the publishers would (nominally) independently set and pay Apple a 30 percent commission for each e-book it sold. Apple further imposed price caps and most-favored-nations (MFN) clauses in the agency agreements with each of the publisher defendants. Apple went on to facilitate the defendant publishers' coordinated imposition of similar agency agreements with Amazon. As the district court observed, "[t]he Apple team reminded the Publishers . . . that this was a rare opportunity for them to achieve control over pricing."5

District Court Condemns Apple's Conduct as Per Se Illegal

Citing Leegin Creative Leather Prods., Inc. v. PSKS, Inc.6 and Texaco Inc. v. Dagher,7 Judge Cote of the Southern District of New York held that Apple had entered into a conspiracy in restraint of trade in violation of Section 1 of the Sherman Act. In so holding, the district court explained that while Section 1 prohibits "unreasonable restraints," "[s]ome agreements . . . are so plainly anticompetitive that no elaborate study of the industry is needed to establish their illegality."8 As such, those "agreements are illegal per se, and are not subject to the rule of reason. The per se rule thus 'eliminates the need to study the reasonableness of an individual restraint in light of the real market forces at work.'"9 Crucially, although vertical price arrangements are entitled to a rule of reason analysis, a horizontal conspiracy to fix prices is not. In the case of a hub-and-spoke conspiracy, as here, "[w]here a vertical actor is alleged to have participated in an unlawful horizontal agreement, plaintiffs must demonstrate both that a horizontal conspiracy existed, and that the vertical player was a knowing participant in that agreement and facilitated the scheme."10 The district court found ample and compelling evidence satisfying this requirement and condemned Apple's behavior as per se illegal.

The district court enjoined Apple from using MFN clauses in its e-book distribution agreements, proscribed Apple from entering into e-book agreements with the defendant publishers similar to the agreements reached under the conspiracy, and imposed antitrust compliance and monitoring requirements upon Apple.11

Second Circuit Affirms That Per Se Standard Applies to Hub-and-Spoke Price-Fixing Conspiracy; Dissent Claims Decision Creates a Circuit Split

Apple argued two central issues, inter alia, on appeal. First, Apple argued that the district court erred in its finding that the company conspired to fix prices with the defendant publishers within the meaning of Section 1 of the Sherman Act. And, second, Apple argued that even if it had orchestrated a price-fixing conspiracy, the district court erroneously applied the per se standard to conduct that should have been analyzed under the rule of reason. Apple's theory was particularly notable because it highlighted the possibility of a circuit split—as expressly noted by the dissent—on the issue of applying the per se standard of liability to hub-and-spoke conspiracies. The dissent cited the Third Circuit's decision in Toledo Mack Sales & Serv., Inc. v. Mack Trucks, Inc. (2008) in support of its reading that Leegin in fact requires that courts analyze hub-and-spoke conspiracies under the full rule of reason.

The Second Circuit's majority rejected Apple's arguments on both of its central claims on appeal. It too cited Leegin, Interstate Circuit, and Toys "R" Us in support of the proposition that "vertical agreements, lawful in the abstract, can in context be useful evidence for a plaintiff attempting to prove the existence of a horizontal cartel . . . particularly where multiple competitors sign vertical agreements that would be against their own interests were they acting independently."12 The court stated that in assessing whether the rule of reason or a per se standard should apply, one must look to the nature of the restraint at issue, not the "reasonableness of a particular defendant's role in the scheme."13 Here, the Second Circuit made clear that the restraint at issue was not Apple's vertical arrangements with the defendant publishers, but rather "the horizontal agreement that Apple organized among the Publisher Defendants to raise ebook prices."14 Further, the court noted that Apple's reliance on—and the dissent's interpretation of—a sentence in Leegin for the proposition that it "rejected per se liability for hub-and-spokes agreements" was inapposite. The Second Circuit sharply observed that such a reading would effectively overturn the Supreme Court's precedent and that the High Court was not in the habit of making momentous changes in law in such a manner without further discussion.

The dissent, for its part, noted that the Third Circuit in Toledo Mack is the only circuit to have considered the per se issue raised by the ambiguous wording in Leegin and interpreted it to mean that hub-and-spoke conspiracies are not eligible for per se treatment. The majority, in turn, harmonized Toledo Mack with its own holding in Apple. The Second Circuit suggested that the Third Circuit's later decision, In re Insurance Brokerage Antitrust Litigation, put Toledo Mack into question where it held that the "crucial issue" in assessing a hub-and-spoke conspiracy under the per se standard is "how the spokes are connected to each other."15 So where plaintiffs can show a conspiracy among the spokes of the conspiracy, application of the per se standard is appropriate. The dissent rejected this argument as a gerrymandered reading of In re Insurance Brokerage, pointing out that the Third Circuit's opinion plainly stated that although the per se standard was properly applied to the horizontal aspects of the conspiracy, post-Leegin, the vertical components of the conspiracy were entitled to rule of reason analysis.

As suggested forcefully by the dissent, the Second Circuit's opinion may have created a circuit split on the issue of whether a hub-and-spoke conspiracy is properly analyzed under a full rule of reason or the truncated per se standard of illegality. If so, it increases the likelihood that Apple will appeal to the Supreme Court, as Apple's comments to the press in the wake of the Second Circuit's ruling indicated it might. Amid the uncertainty, one thing is clear: the Second Circuit's decision reaffirms the prudence of clients avoiding hub-and-spoke conspiracies.

1 952 F. Supp. 2d 638 (S.D.N.Y. 2013).

2 The five defendant publishers, all of which settled with the Department of Justice before trial, were Hachette Book Group, Inc., HarperCollins Publishers LLC, Holtzbrinck Publishers LLC d/b/a Macmillan, Penguin Group (USA), Inc., and Simon & Schuster, Inc. Random House was the sole holdout that refused to participate in Apple's scheme.

3 Apple, 952 F. Supp. 2d at 656.

4 U.S. v. Apple, Inc., Case 13-3741, 36 (2d Cir. June 30, 2015)(internal quotation marks omitted).

5 Apple, 952 F. Supp. 2d at 664.

6 551 U.S. 877, 885 (2007).

7 547 U.S. 1, 5 (2006).

8 Apple, 952 F. Supp. 2d at 688 (citing Texaco, 547 U.S. at 5)(internal quotation marks omitted).

9 Apple, 952 F. Supp. 2d at 688 (citing Leegin, 551 U.S. at 886).

10 Apple, 952 F. Supp. 2d at 690-91 (citing Leegin, 551 U.S. at 886; Toys "R" Us, Inc. v. FTC, 221 F. 3d 928 (7th Cir. 2000).

11 In June 2014, Apple agreed to pay $450 million to settle a related class action lawsuit. A trial on damages had been scheduled for July 2014, wherein the damages award could have been trebled up to $840 million, as the class was seeking $280 million in damages.

12 Apple, Case 13-3741 at 66 (citing Leegin, 551 U.S. at 893; Interstate Circuit, 306 U.S. at 222; Toys "R" Us, 221 F.3d at 935-36)(internal quotation marks omitted).

Although the circuit court went on to observe that the MFNs in Apple's agency contracts "created a set of economic incentives pursuant to which [they] were only attractive to the Publisher Defendants to the extent they acted collectively," it noted that its conclusion "says nothing about [MFNs'] broader legality." Rather, the court stated, the MFNs were assessed within the context of the entirety of Apple's conduct and agency contracts. Id. at 67.

13 Apple at 72 (citing Atl. Richfield, v. USA Petroleum Co., 495 U.S. 328, 342 (1990); Nat'l Collegiate Athletic Ass'n v. Bd. of Regents of the Univ. of Okla., 468 U.S. 85, 103 (1984)).

14 Apple at 75.

15 In re Insurance Brokerage Antitrust Litigation, 618 F.3d 300, 327 (3d Cir. 2010)(citing Total Benefits Planning Agency, Inc. v. Anthem Blue Cross & Blue Shield, 552 F.3d 430, 436 (6th Cir. 2008) (internal quotation marks omitted).