Harrison (Buzz) Frahn
Simpson Thacher & Bartlett LLP
On November 7, 2018, the Federal Trade Commission (the “Commission”) affirmed an Administrative Law Judge’s (“ALJ”) ruling that agreements between online retailers barring them from using each other’s trademarks as keywords in paid search engine advertising algorithms violated Section 5 of the Federal Trade Commission Act (“FTC Act”). In the Matter of 1-800 Contacts, Inc., F.T.C. No. 9372 (November 7, 2018) (the “Commission Opinion”). The decision ends, at least at the Commission, proceedings which began in 2016 when the FTC filed an administrative complaint against online contact lens retailer 1-800 Contacts, Inc. (“1-800 Contacts”) alleging that the company had entered into over a dozen trademark litigation settlement agreements with competitors that unlawfully restrained price competition and the availability of truthful, non-misleading advertising online.Commission Opinion at 10. While acknowledging that the case might appear mundane at first glance, the Commission nonetheless emphasized that the case addressed issues of “enormous import” impacting “the very basic institutions of 21st century commerce.”Id. at 1.
Since its inception as a mail-order contact lens business in 1992, 1-800 Contacts has grown into the nation’s leading online retailer of prescription contact lenses.Id. at 3. According to the Commission, the company has maintained its sales lead despite selling an essentially identical product at higher prices than other online retailers by investing heavily in online and traditional marketing and relying on strong brand recognition.Id. at 3-4, 7.
Like many online retailers, 1-800 Contacts and its competitors advertise via sponsored advertising links on internet search engines such as Google, Bing, and Yahoo!Id. at 5-7. In contrast to standard search algorithms, sponsored search advertising allows advertisers to place bids on key terms that will trigger the appearance of the advertisers’ sponsored links in users’ search results.Id. at 5. Relatedly, advertisers may bid on so-called “negative keywords” which ensure their sponsored links do not appear when a user performs a search for a selected word of phrase.Id. at 6 & n.7. For example, a retailer that sells eyeglasses could use the negative keyword “wine glasses” to prevent its ads from appearing in response to searches for that term.Id.
Starting in 2005, 1-800 Contacts began sending cease and desist letters to many of its online competitors alleging, inter alia, trademark infringement based on the retailers’ advertisements appearing in search results in response to searches for 1-800 Contacts’ trademark terms.Id. at 7-8. Critically, the challenged ads did not themselves include 1-800 Contracts trademark terms, but rather appeared in search results because the competitors had bid on 1-800 Contacts’ trademarked terms.Id. 1-800 Contacts eventually sued several of its competitors, and resolved the majority of the suits with settlement agreements (the “Challenged Agreements”) that prohibited 1-800 Contacts and its competitors from using each other’s trademarks, URLS, and variations of marks as search advertising keywords.Id. at 9. The Challenged Agreements, the last of which was entered into in 2013, likewise required the parties to use “negative” keywords to stop their ads from appearing in searches for each other’s trademarks.Id. at 8-9.
II. PROCEDURAL HISTORY
In 2016 the FTC filed an administrative complaint (the “Complaint”) against 1-800 Contacts, alleging that the Challenged Agreements unreasonably restrained both price competition in search advertising auctions and the availability of truthful, non-misleading advertising in violation of Section 5 of the FTC Act.Id. at 10. In the FTC’s view, the agreements “prevented the parties from disseminating ads that would have informed consumers that identical products were available at different prices, which reduced price competition among online contact lens retailers and made it costlier for consumers to search prices offered by the retailers.”Id. at 10. Also, the Complaint alleged that the Challenged Agreements “undermined the efficiency of search advertising auctions, distorted the prices in those auctions by eliminating bidders, and degraded the quality of service offered by search engines.”Id. at 10. On October 20, 2017, an ALJ agreed with the FTC and barred 1-800 Contacts from enforcing the disputed contract provisions or entering similar agreements in the future.Id.at 11-12.1-800 Contacts appealed to the Commission.Id.
III. THE COMMISSION OPINION
Reviewing the ALJ’s decision de novo, the Commission evaluated 1-800 Contact’s arguments that the Challenged Agreements are immune from antitrust scrutiny and that, regardless, the restrictions in the agreements are not anticompetitive.Id. at 12.
A. The Agreements Are Not Immune From Antitrust Scrutiny
As a preliminary matter, 1-800 Contacts argued that the Supreme Court’s decision in FTC v. Actavis, Inc., 570 U.S. 136 (2013) bars antitrust challenges to settlement agreements that are “commonplace in form,” and that the Challenged Agreements were “commonplace.” Commission Opinion at 12. The Commission rejected 1-800 Contacts’ argument as reading Actavis too broadly, noting that Actavis “did not state a general rule that removes settlement agreements from antitrust scrutiny, but rather characterized two specific types of settlements as commonplace, and made it clear that the form of the settlement alone is not what subjects an agreement to antitrust scrutiny.”Id. at 13.
But even if 1-800 Contacts’ interpretation of Actavis were correct, the Commission reasoned, the agreements at issue would still be subject to antitrust scrutiny because they were not “commonplace.” Rather than simply addressing the potential for consumer confusion in the advertisement itself (like traditional trademark settlements), the agreements eliminated “an entire channel of competitive advertising at the key moment when the consumer is considering a purchase.”Id. at 14. Thus, finding the Challenged Agreements not immune to antitrust scrutiny, the Commission proceeded to the merits of the FTC’s antitrust claims.Id. at 16.
B. The Agreements Violate the FTC Act for Three Independent Reasons
The Complaint alleged violations of Section 5 of the FTC Act, which, like Section 1 of the Sherman Act, imposes a “rule of reason” burden shifting framework.Id. at 16-17 & n.17. Under the rule of reason, a plaintiff must first “prove that the challenged restraint has, or is likely to have, a substantial anticompetitive effect that harms consumers.”Id. at 17. If the plaintiff succeeds, the burden “shifts to the defendant to show a procompetitive rationale for the restraint.”Id. Finally, if such a procompetitive justification is established, the plaintiff must show that it “could be reasonably achieved through less anticompetitive means or that the anticompetitive harms outweigh the procompetitive benefits.”Id.
Applying Supreme Court and FTC precedent, the Commission recognized three independent bases for finding a violation of the FTC Act.
i. The Agreements Violate the Act as “Inherently Suspect” Restraints
The Commission first assessed the Challenged Agreements under the “inherently suspect” mode of analysis outlined in Polygram Holding, Inc., 136 F.T.C. 310, 344 (2003), aff’d, 416 F.3d 29 (D.C. Cir. 2005). Under Polygram, the factfinder assesses whether a restraint has, or is likely to have, anticompetitive effects by looking at the nature of the restraint and considering whether it resembles a practice that has previously been condemned as anticompetitive. Commission Opinion at 18.If it does, Polygram then requires the factfinder to follow a burden-shifting analysis that resembles the rule of reason.Id. at 18-19.
Here, the Commission concluded that the Challenged Agreements “are, in essence, agreements between horizontal competitors to restrict the information provided by advertising to consumers when they search for 1-800 Contacts’ trademark terms and URLs.”Id. at 20. As such, the Commission concluded that the agreements would “raise the cost to consumers of finding the most suitable offering of a product or service” and are therefore inherently suspect.Id.
1. 1-800 Contacts Provided Facially Plausible Procompetitive Justifications
Having found the Challenged Agreements inherently suspect, the Commission next considered whether, under Polygram, 1-800 Contacts had advanced a plausible “link between the challenged restraint and [a] purported justification.”Id. at 22, citing Polygram, 136 F.T.C.at 347. 1-800 Contacts advanced two justifications—the protection of its trademark rights and the avoidance of litigation costs through settlement—and the Commission agreed that both were, in theory, legitimate.Id. at 23.
Hence, following Polygram, the Commission next considered whether the restraints are likely to harm competition by either (1) showing that the anticompetitive effects or procompetitive justifications could have been achieved through less restrictive means; or (2) showing that the restraints are likely in the particular context of the case to harm competition.See id. at 24-25, citing Polygram, 136 F.T.C. at 348-49.
2. Less Anticompetitive Means Exist to Advance Procompetitive Interests, and The Agreements Are Likely to Harm Competition
The Commission determined that 1-800 Contacts’ purported justifications for the Challenged Agreements could have been accomplished through less anticompetitive means. In particular, the Commission identified three alternatives that would avoid litigation costs and achieve the benefits of trademark protection without unduly restricting advertisers.Id. at 27. The three alternatives were: (1) barring competitors from using in their advertisements any text alleged by 1-800 Contacts to cause consumer confusion; (2) requiring clear disclosure in each advertisement of the identity of the competitor; or (3) requiring the competitor to refrain from using confusing or deceptive language in its search ads.Id.
The Commission similarly concluded that the restraints are likely to harm competition in the particular context.Id. at 30. Finding that the volume of searches for 1-800 Contacts’ trademark terms is “significant” and that 1-800 Contacts’ competitors “offer lower prices,” the Commission concluded that the agreements covered the entire landscape of online contact lens retailers and would likely—in fact did—affect contact lens prices and the availability of truthful advertising.Id. at 32-33.
Therefore, because 1-800 Contacts’ procompetitive justifications could be accomplished with less restrictive means, and separately because they were likely to harm competition, the Commission concluded that the FTC had met its burden under Polycorp to show that the Challenged Agreements were inherently suspect.Id. at 29-30, 35-36.
Going one step further, the Commission concluded that because less restrictive alternatives had been identified under the last step of Polycorp, even if the procompetitive justifications set forth by 1-800 Contacts were supported by evidence (as opposed to being merely plausible), the agreements would fail under the third prong of the rule of reason.Id. at 30. The Commission therefore held that the Challenged Agreements violate the FTC Act as inherently suspect restraints. Id at 35-36.
Finally, to round out its analysis the Commission considered the evidence that had been proffered by 1-800 Contacts relating to the two procompetitive justifications, and concluded in both instances that the evidence was insufficient to show that either “ha[s] a basis in fact.”Id. at 36.
ii. Direct Evidence of Anticompetitive Effects Supports Finding a Violation of the Act
As a second, independent basis for finding liability, the Commission determined that the restrictions in the Challenged Agreements satisfy the first prong in the rule of reason analysis based on direct evidence. In particular, the Commission found that the FTC established a prima facie case with “evidence of two anticompetitive effects: the restriction of truthful advertising and an increase in contact lens prices sold online.”Id. at 42.
1-800 Contacts argued that a restriction on truthful advertising could not qualify as an anticompetitive effect.Id. But the Commission disagreed, and noted that the evidence showed that the Challenged Agreements’ requirement to use negative keywords prevented ads from appearing in response to search results and thereby restricted truthful advertising from being provided to consumers.Id. at 43-46. The Commission also found that the FTC had presented direct evidence of a price effect because “insulat[ing] 1-800 Contacts from normal competitive forces and divert[ing] sales from low-priced sellers to a high priced seller is direct evidence of an increase in price.”Id. at 47.
Thus, having found adequate evidence of anticompetitive effects, and relying on its previous analysis with respect to the asserted procompetitive justifications and less restrictive alternatives, the Commission concluded that direct evidence indicated a violation of the FTC Act.Id. at 48-49.
iii. Anticompetitive Effects Relating to Advertising Search Term Auctions Violate the Act
Finally, as a third independent basis for a violation, the Commission concluded that the record revealed a “prima facie case of anticompetitive harm to search engines based on direct evidence.”Id. at 50.Specifically, the Commission found that by agreeing not to bid on each other’s trademark terms, the Challenged Agreements reduce “the number of bidders participating in the auctions.”Id. at 51.Experts from Google and Bing explained that “a reduction in the number of search-advertising auction participants offering relevant ads reduces the price paid by the auction winners and reduces the revenue for the search engine.”Id. The Commission also concluded that the restrictions decreased the quality of the search engines’ product by removing advertisements that would have otherwise been displayed.Id. at 53.Since 1-800 Contacts failed to assert any procompetitive justifications for the anticompetitive effects, the Commission concluded that a violation was established under the first prong of the rule of reason.
Finding that the restraints in the Challenged Agreements violate the FTC Act, the Commission affirmed the ALJ’s order barring 1-800 Contacts “from agreeing with any seller of contact lens products to limit participation in online search advertising auctions (including restricting the use of keywords or requiring the use of negative keywords) or to limit online search advertising.”Id. at 54.
The Commission concluded by recognizing that its decision “evaluated traditional concerns of antitrust law—the anticompetitive harms that flow when rivals agree to restrict truthful advertising and to limit their participation in auctions—in a contemporary context involving online shopping and advertising via internet search engines.”Id. at 59. Concerned that withholding information from consumers “frustrates their ability to compare the prices and offerings of competitors,” it found “that the agreements harm consumers and competition for the online sale of contact lenses.”Id. at 2.On December 10, 1-800 Contacts asked the Commission to stay its order pending a review by a U.S. Court of Appeals. If an appeals court affirms the Commission’s decision, competitors will likely need to avoid limiting consumer access to information in search results when settling disputes.