21.1: Sherman Act

Learning Objectives

• What is the first U.S. antitrust law?
• What is antitrust anyway?

In archaic language, a trust (which is now known as a cartel) was a group of firms acting in concert. The antitrust laws that made such trusts illegal were intended to protect competition. In the United States, these laws are enforced by the U.S. Department of Justice’s (DOJ) Antitrust Division and by the Federal Trade Commission (FTC). The United States began passing laws during a time when some European nations were actually passing laws forcing firms to join industry cartels. By and large, however, the rest of the world has since copied the U.S. antitrust laws in one form or another.

The Sherman Act, passed in 1890, was the first significant piece of antitrust legislation. It has two main requirements.

Section 1. Trusts, etc., in restraint of trade illegal; penalty

Every 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 declared to be illegal. Every person who shall make any contract or engage in any combination or conspiracy hereby declared to be illegal shall be deemed guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding $10,000,000 if a corporation, or, if any other person, $350,000, or by imprisonment not exceeding 3 years, or by both said punishments, in the discretion of the court.

Section 2. Monopolizing trade a felony; penalty

Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding $10,000,000 if a corporation, or, if any other person, $350,000, or by imprisonment not exceeding 3 years, or by both said punishments, in the discretion of the court.The current fines were instituted in 1974; the original fines were $5,000, with a maximum imprisonment of one year. The Sherman Act is 15 U.S.C. § 1.

The phrase in restraint of trade is challenging to interpret. Early enforcement of the Sherman Act followed the Peckham Rule, named for noted Justice Rufus Peckham, which interpreted the Sherman Act to prohibit contracts that reduced output or raised prices while permitting contracts that would increase output or lower prices. In one of the most famous antitrust cases ever, the United States sued Standard Oil, which had monopolized the transportation of oil from Pennsylvania to the East Coast cities of the United States in 1911.

The exact meaning of the Sherman Act had not been settled at the time of the Standard Oil case. Indeed, Supreme Court Justice Edward White suggested that, because contracts by their nature set the terms of trade and thus restrain trade to those terms, and Section 1 makes contracts restraining trade illegal, one could read the Sherman Act to imply that all contracts were illegal. Chief Justice White concluded that, because Congress couldn’t have intended to make all contracts illegal, the intent must have been to make unreasonable contracts illegal, and he therefore concluded that judicial discretion is necessary in applying the antitrust laws. In addition, Chief Justice White noted that the act makes monopolizing illegal, but doesn’t make having a monopoly illegal. Thus, Chief Justice White interpreted the act to prohibit certain acts leading to monopoly, but not monopoly itself.

The legality of monopoly was further clarified through a series of cases, starting with the 1945 Alcoa case, in which the United States sued to break up the aluminum monopoly Alcoa. The modern approach involves a two-part test. First, does the firm have monopoly power in a market? If it does not, no monopolization has occurred and there is no issue for the court. Second, if it does, did the firm use illegal tactics to extend or maintain that monopoly power? In the language of a later decision, did the firm engage in “the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of superior product, business acumen or historic accident” (U.S. v. Grinnell, 1966)?

There are several important points that are widely misunderstood and even misreported in the press. First, the Sherman Act does not make having a monopoly illegal. Indeed, three legal ways of obtaining a monopoly—a better product, running a better business, or luck—are mentioned in one decision. It is illegal to leverage an existing monopoly into new products or services, or to engage in anticompetitive tactics to maintain the monopoly. Moreover, you must have monopoly power currently to be found guilty of illegal tactics.

When the DOJ sued Microsoft over the incorporation of the browser into the operating system and other acts (including contracts with manufacturers prohibiting the installation of Netscape), the allegation was not that Windows was an illegal monopoly. The DOJ alleged Microsoft was trying to use its Windows monopoly to monopolize another market, the Internet browser market. Microsoft’s defense was twofold. First, it claimed not to be a monopoly, citing the 5% share of Apple. (Linux had a negligible share at the time.) Second, it alleged that a browser was not a separate market but an integrated product necessary for the functioning of the operating system. This defense follows the standard two-part test.

Microsoft’s defense brings up the question, What is a monopoly? The simple answer to this question depends on whether there are good substitutes in the minds of consumers, so that they may substitute an alternate product in the event of bad behavior by the seller. By this test, Microsoft had an operating system monopoly; in spite of the fact that there was a rival product, Microsoft could increase the price, tie the browser and MP3 player to the operating system, or even disable Word Perfect, and most consumers would not switch to the competing operating system. However, Microsoft’s second defense, that the browser wasn’t a separate market, was a much more challenging defense to assess.

The Sherman Act provides criminal penalties, which are commonly applied in price-fixing cases—that is, when groups of firms join together and collude to raise prices. Seven executives of General Electric (GE) and Westinghouse, who colluded in the late 1950s to set the prices of electrical turbines, each spent several years in jail, and incurred over $100 million in fines. In addition, Archer Daniels Midland executives went to jail after their 1996 conviction for fixing the price of lysine, which approximately doubled the price of this common additive to animal feed. When highway contractors are convicted of bid-rigging, the conviction is typically under the Sherman Act for monopolizing their market.

KEY TAKEAWAYS

• A trust (now known as a cartel) is a group of firms acting in concert. The antitrust laws made such trusts illegal and were intended to protect competition. In the United States, these laws are enforced by the Department of Justice’s (DOJ) Antitrust Division and by the Federal Trade Commission (FTC).
• The Sherman Act, passed in 1890, is the first significant piece of antitrust legislation. It prevents mergers and cartels that would increase prices.
• Having a monopoly is legal, provided it is obtained through legal means. Legal means include “superior product, business acumen or historic accident.”
• Modern antitrust investigations involve a two-part test. First, does the firm have monopoly power in a market? If it does not, no monopolization has occurred and there is no issue for the court. If it does, did the firm use illegal tactics to extend or maintain that monopoly power?
• The Sherman Act provides criminal penalties, which are commonly applied in price-fixing cases.