ANTITRUST & TRADE REGULATION SEMINAR Santa Fe July A Legal Framework For Indirect Purchaser Class Actions Why Understanding the Economics of Pass-Through Matters More Than Ever Paul H. Friedman Partner

1 Indirect Purchaser Claims Arise Under State Law  Hanover Shoe v. United Shoe Machinery Corp., 392 U.S. 481 (1968) –The victim of an overcharge is damaged within the meaning of § 4 of the Clayton Act to the extent of the overcharge –The pass-on defense generally is not available even if the plaintiff passed on all or part of the overcharge –No defensive use of pass-through under federal antitrust law

2 Indirect Purchaser Claims Arise Under State Law  Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977) –Hanover Shoe principle bars an indirect purchaser from maintaining a claim against a remote seller for illegal overcharges allegedly passed down through the distribution chain –No offensive use of pass-through

3 Indirect Purchaser Claims Arise Under State Law  States adopt Illinois Brick repealers –25 states and D.C. explicitly permit direct and indirect purchasers to recover damages for state law antitrust violations –Other states permit indirect purchasers to recover under state consumer protection laws –California v. ARC America Corp., 490 U.S. 93 (1989) holds no preemption of state law indirect purchaser statutes

4 CAFA Increased the Likelihood of Federal Court Jurisdiction  Prior to 2005, most jurisprudence on pass- through came from the state courts  The Class Action Fairness Act of 2005 (CAFA) significantly expanded federal diversity jurisdiction over class actions  Several district courts have applied CAFA’s relaxed diversity jurisdiction requirements to support jurisdiction over indirect purchaser class actions –In re Intel Corp. Microprocessor Antitrust Litig. –In re OSB Antitrust Litig.

5 Pass-Through Is an Essential Element of an Indirect Case  Direct purchaser must prove i) a violation; ii) impact; and iii) amount of damages  Indirect purchaser must prove the above AND pass-through –“Proof of impact has been far more troubling for plaintiffs proposing class certification of indirect purchasers. Because indirect purchasers must demonstrate that any overcharges resulting from the illegal action of the defendants have been passed on to them, an entirely separate level of evidence and proof is injected into [indirect purchaser litigation].” Karofsky, 1997 WL at 11

6 Pass-Through Is an Essential Element of an Indirect Case  Every indirect purchaser must prove antitrust injury or impact –Requires proof that The indirect purchaser paid more than it would have absent the alleged illegal conduct The higher price resulted from the alleged illegal conduct In other words, the remote purchaser must show that the original unlawful conduct caused the remote purchaser to pay more

7 Pass-Through Is an Essential Element of an Indirect Case  Since indirect purchaser does not deal directly with the alleged wrongdoer, indirect purchaser must show that all intermediaries passed through some or all of the overcharge –Pass-through must be shown at each level of distribution –If any intermediate absorbs the price increase, there is no pass-through

8 Pass-Through Must Be Addressed At Class Certification  Rule 23 (b)(3) requires plaintiffs to demonstrate that they have a method that uses common class-wide proof to show that each proposed class member paid more than it would have by reason of the alleged conspiracy  Where individualized inquiries of impact predominate, certification should be denied

9 A Case Study: In re OSB Antitrust Litigation  Indirect purchasers of oriented strand board (OSB), a building material used in home construction, sued on behalf of –Buyers of new homes –Buyers of home renovation services –Do-it-yourselfers who bought OSB

10 A Case Study: In re OSB Antitrust Litigation  Confounding factors affecting class-wide proof of pass-through –Complex distribution channels –Different product/different market –OSB accounted for tiny fraction of cost of home –Most home buyers were 1-time buyers during class period –Different supply and demand factors affecting OSB and housing markets

11 A Case Study: In re OSB Antitrust Litigation  Court denied certification of proposed home buyer class –Plaintiffs have not shown that impact and causation are susceptible of common proof –Court rejected plaintiffs’ economic testimony because expert failed to identify the variables needed to prove theory of pass-through of OSB overcharges to home price –Court faulted plaintiffs’ economist for relying “almost entirely on economic theory and generalizations about market competitiveness and ‘elasticities’ of supply and demand without analyzing the competitiveness or elasticities of actual housing markets.”

12 A Case Study: In re OSB Antitrust Litigation  Court did certify DIY class –Plaintiffs’ economist traced channels of distribution from manufacturer to distributor to reseller and found pass-through nearly 100% –Plaintiffs’ economist appears to have considered appropriate variables and data in creating regression –Plaintiffs showed that impact to end users who purchased actual OSB is susceptible of common proof

13 A Case Study: In re OSB Antitrust Litigation  OSB court relied heavily on the following passage from Illinois Brick: –Under an array of simplifying assumptions, economic theory provides a precise formula for calculating how the overcharge is distributed between the [passer] and its customers (passees). … Even if these assumptions are accepted, there remains a serious problem of measuring the relevant elasticities, the percentage change in the quantities of the passer’s product demanded and supplied in response to a one percent change in price. In view of these difficulties … it is unrealistic to think that elasticity studies introduced by expert witnesses will resolve the pass-on issue

14 What’s Next?  Will Congress adopt the AMC’s proposal –Overrule Illinois Brick and Hanover Shoe –Allow removal of indirect purchaser actions –Allow consolidation of direct and indirect purchaser actions –Limit damages to overcharges—trebled –Apportion damages among all plaintiffs based on actual damages suffered

15 What’s Next  Will the EC’s White Paper on Private Damages for Cartel Infringement lead to new damage actions in Europe –Indirect purchaser actions—including actions by residual purchasers—would be allowed –Passing-on defense would be available –But indirect purchasers would benefit from rebuttable presumption that illegal overcharge passed on to them in entirety –Overcharge and lost profits both would be recoverable

16 What’s Next  The need for economic analysis of pass-through will only grow

ANTITRUST & TRADE REGULATION SEMINAR Santa Fe July A Legal Framework For Indirect Purchaser Class Actions Why Understanding the Economics of Pass-Through Matters More Than Ever Paul H. Friedman Partner