Sherman Anti-Trust Act

Sherman Anti-Trust Act

The Sherman Anti-Trust Act of 1890 (15 U.S.C.A. §§ 1 et seq.), the first and most significant of the U.S. antitrust laws, was signed into law by President Benjamin Harrison and is named after its primary supporter, Ohio Senator John Sherman.

The prevailing economic theory supporting antitrust laws in the United States is that the public is best served by free competition in trade and industry. When businesses fairly compete for the consumer's dollar, the quality of products and services increases while the prices decrease. However, many businesses would rather dictate the price, quantity, and quality of the goods that they produce, without having to compete for consumers. Some businesses have tried to eliminate competition through illegal means, such as fixing prices and assigning exclusive territories to different competitors within an industry. Antitrust laws seek to eliminate such illegal behavior and promote free and fair marketplace competition.

Until the late 1800s the federal government encouraged the growth of big business. By the end of the century, however, the emergence of powerful trusts began to threaten the U.S. business climate. Trusts were corporate holding companies that, by 1888, had consolidated a very large share of U.S. manufacturing and mining industries into nationwide monopolies. The trusts found that through consolidation they could charge Monopoly prices and thus make excessive profits and large financial gains. Access to greater political power at state and national levels led to further economic benefits for the trusts, such as tariffs or discriminatory railroad rates or rebates. The most notorious of the trusts were the Sugar Trust, the Whisky Trust, the Cordage Trust, the Beef Trust, the Tobacco Trust, John D. Rockefeller's Oil Trust (Standard Oil of New Jersey), and J. P. Morgan's Steel Trust (U.S. Steel Corporation).

Consumers, workers, farmers, and other suppliers were directly hurt monetarily as a result of the monopolizations. Even more important, perhaps, was that the trusts fanned into renewed flame a traditional U.S. fear and hatred of unchecked power, whether political or economic, and particularly of monopolies that ended or threatened equal opportunity for all businesses. The public demanded legislative action, which prompted Congress, in 1890, to pass the Sherman Act. The act was followed by several other antitrust acts, including the Clayton Act of 1914 (15 U.S.C.A. §§ 12 et seq.), the Federal Trade Commission Act of 1914 (15 U.S.C.A. §§ 41 et seq.), and the Robinson-Patman Act of 1936 (15 U.S.C.A. §§ 13a, 13b, 21a). All of these acts attempt to prohibit anticompetitive practices and prevent unreasonable concentrations of economic power that stifle or weaken competition.

The Sherman Act made agreements "in restraint of trade" illegal. It also made it a crime to "monopolize, or attempt to monopolize … any part of the trade or commerce." The purpose of the act was to maintain competition in business. However, enforcement of the act proved to be difficult. Congress had enacted the Sherman Act pursuant to its constitutional power to regulate interstate commerce, but this was only the second time that Congress relied on that power. Because Congress was somewhat uncertain of the reach of its legislative power, it framed the law in broad common-law concepts that lacked detail. For example, such key terms as monopoly and trust were not defined. In effect, Congress passed the problem of enforcing the law to the Executive Branch, and to the judicial branch, it gave the responsibility of interpreting the law. Still, the act was a far-reaching legislative departure from the predominant laissez-faire philosophy of the era.

Initial enforcement of the Sherman Act was halting, set back in part by the decision of the Supreme Court in United States v. E. C. Knight Co., 156 U.S. 1, 15 S. Ct. 249, 39 L. Ed. 325 (1895), that manufacturing was not interstate commerce. This problem was soon circumvented, and President Theodore Roosevelt promoted the antitrust cause, calling himself a "trustbuster." In 1914, Congress established the Federal Trade Commission (FTC) to formalize rules for fair trade and to investigate and curtail unfair trade practices. As a result, a number of major cases were successfully brought in the first decade of the century, largely terminating trusts and basically transforming the face of U.S. industrial organization.

During the 1920s, enforcement efforts were more modest, and during much of the 1930s, the national recovery program of the New Deal encouraged industrial collaboration rather than competition. During the late 1930s, an intensive enforcement of antitrust laws was undertaken. Since World War II, antitrust enforcement has become increasingly institutionalized in the Antitrust Division of the Justice Department and in the Federal Trade Commission, which over time, was granted greater authority by Congress. Justice Department enforcement activities against cartels are particularly vigorous, and criminal sanctions are increasingly sought. In 1992, the Justice Department expanded its enforcement policy to cover foreign company conduct that harms U.S. exports.

Restraint of Trade

Section one of the Sherman Act provides that "[e]very contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states, or with foreign nations is hereby declared to be illegal." The broad language of this section has been slowly defined and narrowed through judicial decisions.

The courts have interpreted the act to forbid only unreasonable restraints of trade. The Supreme Court promulgated this flexible rule, called the Rule of Reason, in Standard Oil Co. of New Jersey v. United States, 221 U.S. 1, 31 S. Ct. 502, 55 L. Ed. 619 (1911). Under the Rule of Reason, the courts will look to a number of factors in deciding whether the particular restraint of trade unreasonably restricts competition. Specifically, the court considers the makeup of the relevant industry, the defendants' positions within that industry, the ability of the defendants' competitors to respond to the challenged practice, and the defendants' purpose in adopting the restraint. This analysis forces courts to consider the pro-competitive effects of the restraint as well as its anticompetitive effects.

The Supreme Court has also declared certain categories of restraints to be illegal per se: that is, they are conclusively presumed to be unreasonable and therefore illegal. For those types of restraints, the court does not have to go any further in its analysis than to recognize the type of restraint, and the plaintiff does not have to show anything other than that the restraint occurred.

Restraints of trade can be classified as horizontal or vertical. A horizontal agreement is one involving direct competitors at the same level in a particular industry, and a vertical agreement involves participants who are not direct competitors because they are at different levels. Thus, a horizontal agreement can be among manufacturers or retailers or wholesalers, but it does not involve participants from across the different groups. A vertical agreement involves participants from one or more of the groups—for example, a manufacturer, a wholesaler, and a retailer. These distinctions become difficult to make in certain fact situations, but they can be significant in determining whether to apply a per se rule of illegality or the Rule of Reason. For example, horizontal market allocations are per se illegal, but vertical market allocations are subject to the rule-of-reason test.

Concerted Action

Section one of the Sherman Act prohibits concerted action, which requires more than a unilateral act by a person or business alone. The Supreme Court has stated that an organization may deal or refuse to deal with whomever it wants, as long as that organization is acting independently. But if a manufacturer and certain retailers agree that a manufacturer will only provide products to those retailers and not to others, then that is a concerted action that may violate the Sherman Act. A company and its employees are considered an individual entity for the purposes of this act. Likewise, a parent company and its wholly owned subsidiaries are considered an individual entity.

Evidence of a concerted action may be shown by an express or written agreement, or it may be inferred from Circumstantial Evidence. Conscious parallelism (similar patterns of conduct among competitors) is not sufficient in and of itself to imply a conspiracy. The courts have held that conspiracy requires an additional element such as complex actions that would benefit each competitor only if all of them acted in the same way.

Joint ventures, which are a form of business association among competitors designed to further a business purpose, such as sharing cost or reducing redundancy, are generally scrutinized under the Rule of Reason. But courts first look at the reason that the Joint Venture was established to determine whether its purpose was to fix prices or engage in some other unlawful activity. Congress passed the National Cooperative Research Act of 1984 (15 U.S.C.A. §§ 4301-06) to permit and encourage competitors to engage in joint ventures that promote research and development of new technologies. The Rule of Reason will apply to those types of joint ventures.

Price Fixing

The agreement to inhibit price competition by raising, depressing, fixing, or stabilizing prices is the most serious example of a per se violation under the Sherman Act. Under the act, it is immaterial whether the fixed prices are set at a maximum price, a minimum price, the actual cost, or the fair market price. It is also immaterial under the law whether the fixed price is reasonable.

All horizontal and vertical price-fixing agreements are illegal per se. Horizontal price-fixing agreements include agreements among sellers to establish maximum or minimum prices on certain goods or services. This can also include competitors' changing their prices simultaneously in some circumstances. Also significant is the fact that horizontal price-fixing agreements may be direct or indirect and still be illegal. Thus, a promotion or discount that is tied closely to price cannot be raised, depressed, fixed, or stabilized, without a Sherman Act violation. Vertical price-fixing agreements include situations where a wholesaler mandates the minimum or maximum price at which retailers may sell certain products.

Market Allocations

Market allocations are situations where competitors agree to not compete with each other in specific markets, by dividing up geographic areas, types of products, or types of customers. Market allocations are another form of price fixing. All horizontal market allocations are illegal per se. If there are only two computer manufacturers in the country and they enter into a market allocation agreement whereby manufacturer A will only sell to retailers east of the Mississippi and manufacturer B will only sell to retailers west of the Mississippi, they have created monopolies for themselves, a violation of the Sherman Act. Likewise, it is an illegal agreement that manufacturer A will only sell to retailers C and D and manufacturer B will only sell to retailers E and F.

Territorial and customer vertical market allocations are not per se illegal but are judged by the Rule of Reason. In 1985, the Justice Department announced that it would not challenge any restraints by a company that has less than 10 percent of the relevant market or whose vertical price index, a measure of the relevant market share, indicates that collusion and exclusion are not possible for that company in that market.

Boycotts

A boycott, or a concerted refusal to deal, occurs when two or more companies agree not to deal with a third party. These agreements may be clearly anticompetitive and may violate the Sherman Act because they can result in the elimination of competition or the reduction in the number of participants entering the market to compete with existing participants. Boycotts that are created by groups with market power and that are designed to eliminate a competitor or to force that competitor to agree to a group standard are per se illegal. Boycotts that are more cooperative in nature, designed to increase economic efficiency or make markets more competitive, are subject to the Rule of Reason. Generally, most courts have found that horizontal boycotts, but not vertical boycotts, are per se illegal.

Tying Arrangements

When a seller conditions the sale of one product on the purchase of another product, the seller has set up a Tying Arrangement, which calls for close legal scrutiny. This situation generally occurs with related products, such as a printer and paper. In that example, the seller only sells a certain printer (the tying product) to consumers if they agree to buy all their printer paper (the tied product) from that seller.

Tying arrangements are closely scrutinized because they exploit market power in one product to expand market power in another product. The result of tying arrangements is to reduce the choices for the buyer and exclude competitors. Such arrangements are per se illegal if the seller has considerable economic power in the tying product and affects a substantial amount of interstate commerce in the tied product. If the seller does not have economic power in the tying product market, the tying arrangement is judged by the Rule of Reason. A seller is considered to have economic power if it occupies a dominant position in the market, its product is advantaged over other competing products as a result of the tying, or a substantial number of consumers has accepted the tying arrangement (evidencing the seller's economic power in the market).

Monopolies

Section two of the Sherman Act prohibits monopolies, attempts to monopolize, or conspiracies to monopolize. A monopoly is a form of market structure where only one or very few companies dominate the total sales of a particular product or service. Economic theories show that monopolists will use their power to restrict production of goods and raise prices. The public suffers under a monopolistic market because it does not have the quantity of goods or the low prices that a competitive market could offer.

Although the language of the Sherman Act forbids all monopolies, the courts have held that the act only applies to those monopolies attained through abused or unfair power. Monopolies that have been created through efficient, competitive behavior are not illegal under the Sherman Act, as long as honest methods have been employed. In determining whether a particular situation that involves more than one company is a monopoly, the courts must determine whether the presence of monopoly power exists in the market. Monopoly power is defined as the ability to control price or to exclude competitors from the marketplace. The courts look to several criteria in determining market power but primarily focus on market share (the company's fractional share of the total relevant product and geographic market). A market share greater than 75 percent indicates monopoly power, a share less than 50 percent does not, and shares between 50 and 75 percent are inconclusive in and of themselves.

In focusing on market shares, courts will include not only products that are exactly the same but also those that may be substituted for the company's product based on price, quality, and adaptability for other purposes. For example, an oat-based, round-shaped breakfast cereal may be considered a substitutable product for a rice-based, square-shaped breakfast cereal, or possibly even a granola breakfast bar.

In addition to the product market, the geographic market is also important in determining market share. The relevant geographic market, the territory in which the firm sells its products or services, may be national, regional, or local in nature. Geographic market may be limited by transportation costs, the types of product or service, and the location of competitors.

Once sufficient monopoly power has been proved, the Sherman Act requires a showing that the company in question engaged in unfair conduct. The courts have differing opinions as to what constitutes unfair conduct. Some courts require the company to prove that it acquired its monopoly power passively or that the power was thrust upon them. Other courts consider it an unfair power if the monopoly power is used in conjunction with conduct designed to exclude competitors. Still other courts find an unfair power if the monopoly power is combined with some predatory practice, such as pricing below marginal costs.

Attempts to Monopolize Section two of the Sherman Act also prohibits attempts to monopolize. As with other behavior prohibited under the Sherman Act, courts have had a difficult time developing a standard that distinguishes unlawful attempts to monopolize from normal competitive behavior. The standard that the courts have developed requires a showing of Specific Intent to monopolize along with a dangerous probability of success. However, the courts have no uniform definition for the terms intent or success. Cases suggest that the more market power a company has acquired, the less flagrant its attempt to monopolize must be.

Conspiracies to Monopolize Conspiracies to monopolize are unlawful under section two of the Sherman Act. This offense is rarely charged alone, because a conspiracy to monopolize is also a combination in restraint of trade, which violates section one of the Sherman Act.

In accordance with traditional conspiracy law, conspirators to monopolize are liable for the acts of each co-conspirator, even their superiors and employees, if they are aware of and participate in the overall mission of the conspiracy. Conspirators who join in the conspiracy after it has already started are liable for every act during the course of the conspiracy, even those events that occurred before they joined.

Further readings

Hylton, Keith N. 2003. Antitrust Law: Economic Theory and Common Law Evolution. New York: Cambridge Univ. Press.

Mann, Richard A., and Barry S. Roberts. 2004. Essentials of Business Law. 8th ed. Mason, Ohio: Thomson/South-Western West.

Posner, Richard A. 2002. Antitrust Law. 2d ed. Chicago: Univ. of Chicago Press.

Cross-references

Antitrust Law; Mergers and Acquisitions; Unfair Competition; Vertical Merger.