Mr. MAZZOLI. You understand that I am asking questions based upon one who has problems with class action suits.

Mr. MURPHY. Yes, sir.

Mr. MazzoLI. I voted last week to strike section 7 of the FTC Act amendments because I have concerns about just where we're going just how we're going to get there. But at the same time, I'm struck by what appears to be an attitude of wanting your cake and eating it, too, because you want to have defensive pass through but you don't want to have offensive use of pass through.

Mr. MURPHY. No, if I could interrupt you

Mr. MAZZOLI. Please.

Mr. MURPHY. At that point, I'm prepared to live with the law as it was before Illinois Brick.

Mr. MAZZOLI. Which is the Hanover Shoe case, which again puts the burden apparently on the middleman or the direct purchaser, who, I must say, I'm not persuaded has the same kind of aggressive instincts about going against the overcharger because, as you have already pointed out in your answer to the gentleman from New Jersey, a commercial matter could perhaps intervene.

So tell me, how can we

Mr. MURPHY. The difficulty I have here is that I think there are cases-and I happen to think the facts of the Illinois Brick case were one in which the plaintiff, even though as a conceptual matter you might assume he's injured, ought not to be able to recover because his recovery is just so complicated that any overcharge he might have borne is just buried in the building.

I think it is the problem, and in that event, he ought to be stuck offensively, as we are stuck defensively, under Hanover Shoes. Mr. MAZZOLI. The Chair's time has expired.

The gentleman from Maine, Mr. Cohen.

Mr. COHEN. Thank you, Mr. Chairman.

Mr. Murphy, you indicated just now that you could live with the law as it was prior to the Illinois Brick case. Could you live with the law as originally intended by this committee when it passed parens patriae? Did you favor that answer?

Mr. MURPHY. No, sir; I stated that I did not favor that.

Mr. COHEN. I was wondering, because you also indicated the Justice Department proposes to have a 15-member commission or committee to study ways in which we could shorten antitrust litigation or simplify it, if at all possible. The Justice Department, as a matter of fact, was the initiator for this committee on parens patriae legislation. Mr. Kauper testified on a couple of occasions before this subcommittee and the Senate subcommittee, and only in the last month before passage last year did the administration reverse its position and come out in opposition to parens patriae.

So I was wondering, based upon your own information, is it now the case that the Justice Department does not favor the parens patriae legislation as originally passed by this committee and by this House? Is that your understanding when you gave the implication the Justice Department is not too sure now about what the implicationsMr. MURPHY. I didn't mean to give that implication. All I said was that the Justice Department has announced that it wants to establish a commission to review two aspects of the antitrust laws, and one of them is how do you make antitrust trials shorter and more efficient?

This question seems to me directly related to their charter, and I should think that you might benefit from their views. It seems to me that the problem with the Illinois Brick decision is it has language in it which some people can say goes too far.

I would prefer to have seen the Supreme Court reach the result it did on the facts of that case. I think that would have been a just and proper result, and I believe that if you give the law a chance to develop, that's where it's going to come out. There are going to be some cases in which indirect purchasers will be held to have standing to sue on a cause of action and will recover on the appropriate facts and they will probably come up in the parens patriae field.

Mr. COHEN. On page 7 of your statement, you indicated that there are to be enormous problems presented by a large class of claimants representing every conceivable level of distribution. And assuming that some kind of recommendation is going to come out of this subcommittee or full committee to the House dealing with Illinois Brick, and short of allowing the Supreme Court itself to develop law or interpretation under Illinois Brick, what would you recommend in the way of statutory guidelines to eliminate the amount of complexity or confusion, you refer to in your statement on page 7? Is there anything short of just doing nothing and allowing it to develop?

Mr. MURPHY. Well, one suggestion I have heard is to limit the legislation for parens patriae suits, and I think that that will eliminate some of the complexity because you don't have problems of notice, and this, that, and the other thing.

Judge Tyler suggested to you that you might consider various kinds of presumptions. If it can be done with a draftsman's ability, you might be able to write a statutory presumption that with respect to consumer goods-like a potato chip there in fact is a pass-on to the consumer, and in other goods like cement, there isn't.

Mr. COHEN. Mr. Cooper, you confused me a little by your last statement. I gathered, at least I've got this assumption, that when you're talking about the court establishing so much in the amount of damages and you either participate in that share of damages or there is no money to distribute. It seems to me the implication was that your system is somehow circumventing opt-out provisions of the law.

Mr. COOPER. I'm not circumventing-well, I am and I'm not. You can opt out of a class, but there are interpleader provisions which go on all the time in the courts, where there are multiple potential claimants to a body of money, who it belongs to when the money exists. The question is who is entitled to it? And the courts will say everyone who is entitled to it come in and tell us how much, if at all, you're entitled to, and we will make a determination and we'll resolve this matter. What I'm saying to you is that these procedures, even if someone excludes themselves from the class, those procedures can be applied once you have an adjudication that there is a violation and how much the overcharge, the damages, have been.

Now, that doesn't mean that a person can't exclude himself from the class for purposes of saying, I don't like the lawyer for the class and I think he's incompetent and I don't want to be bound if he loses

the case.

Mr. COHEN. What is the practical effect of that, even though you exclude yourself and prefer to try with your own counsel; whatever is established by the class action, you're bound by that determination

as far as the assessment of damages and your prorated share, are you not?

Mr. COOPER. Only at the point in time where the fund has been established and these issues have been litigated.

If, in fact, the class counsel loses the case, then the party who is unhappy-I'm using the example of a class counsel as being the reason he's unhappy-it could be any other reason. But if the class counsel loses the case, then the person who opted out has reserved his right, albeit perhaps duplicative, to litigate again, and that right exists today, and Illinois Brick hasn't affected that right.

Mr. Mazzoli. Excuse me. The gentleman's time has expired. I will allow 2 minutes apiece.

Will the gentleman from California lead off, if he has additional questions?

Mr. WIGGINS. Mr. Chairman, I yield.

Mr. MAZZOLI. Very good. The gentleman from New Jersey.

Mr. HUGHES. I vield.

Mr. MAZZOLI. The gentleman from Illinois, Mr. McClory?
Mr. McCLORY. I yield.

Mr. MAZZOLI. The gentleman from Maine.

Mr. COHEN. Thank you.

Mr. MAZZOLI. Thank you, gentleman. I appreciate your testimony. It may be that we will submit questions to you for written responses, and I am sure that we will give you plenty of time for it. You have been very helpful and we thank you for your time this morning.

The next panel that the Chair will call forward will be composed of Mr. Peter Max, an economist with the National Economic Research Associates, and Professor Richard Posner, professor of law, University of Chicago Law School.

Gentlemen, you have heard me talk with the other witnesses and you know our time constraints. Your written statements will be made, without objection, a part of the record. And then we will proceed with questions from the panel.

And perhaps we'll start with Mr. Posner, since you are in my direct line of sight.

[The prepared statement of Mr. Posner follows:]

STATEMENT OF RICHARD A. POSNER

October 12, 1977

My name is Richard A. Posner. I am Professor of Law at the University of Chicago, where I teach antitrust law and the application of economics to law. My curriculum vitae is attached.

1

I appear here this morning to testify concerning the pros and cons of amending the antitrust laws to overrule the Supreme Court's recent Illinois Brick decision and thereby permit indirect purchasers to maintain treble-damage suits. It is my opinion that such legislation would be unwise."

1. The primary objective of the private antitrust damage action is to deter antitrust violations. The object of compensating the victims of antitrust violations is secondary because an effective system of deterrents would reduce the number of violations, and hence the occasions for compensation, to a low level. But whatever importance one may assign to the compensatory objective, that objective cannot be achieved through indirect-purchaser suits.

1 Illinois Brick Co. v. Illinois, 97 S. Ct. 1061 (1977).

2 See my Antitrust: Cases. Economic Notes, and Other Materials 149 (1974), for an earlier, and consistent, expression of my views on the general question.

As will be explained in the third section of my statement, the effect of a price increase tends to be diffused broadly throughout the chain of distribution, and under plausible assumptions will be felt mainly not by any of the intermediate sellers but rather by ultimate consumers and by certain of the intermediate sellers' suppliers. Those suppliers will ordinarily be barred by the rules of standing from maintaining actions to recover the losses caused them by the remote antitrust violation. As for the ultimate consumer, though in principle he could (assuming Illinois Brick were overruled) seek redress through the class-action device, the reality is that the administrative costs of the class action tend to devour the proceeds of the action, with the result that little compensation actually reaches the ultimate consumer.3

To be sure, other indirect purchasers, such as retailers in a two-tiered (wholesale and retail) distribution system, are in a better position to collect a meaningful judgment than the ultimate consumer. But since they, like direct purchasers, will often be able to pass on most of the costs of an unlawful price increase to their customers and suppliers, allowing them to sue may not further substantially the compensatory objective of the private suit.

2. The issue is then whether Illinois Brick helps or hurts deterrence. From the standpoint of deterrence, the most important thing is not who gets the proceeds of any judgment levied against the antitrust violator but that the judgment equal the social costs of the violation (adjusted appropriately to reflect the probability that the violator will be brought to bar)' and that there be adequate incentives to bring suit and prosecute it to judgment. These objectives, especially the second, are more likely to be achieved by the rule of Illinois Brick than by allowing indirect-purchaser suits. The first purchaser is in the best position to detect an antitrust violation by his seller. Therefore, it is important that he have adequate incentives to bring suit against the seller, and he will-if he can sue for the entire overcharge. But if indirect purchasers can sue to the extent they are actually injured, then as a necessary corollary the seller, in a suit by the first purchaser, will be able to defend to the extent that the first purchaser passed on any part of the overcharge to his customers or suppliers." Insofar as the defendant succeeds in this defense, the incentives of first purchasers to sue are weakened (and in the limit vanish), and the likelihood that violators will be detected is therefore diminished.

Injured indirect purchasers will, to be sure, have an incentive to sue that is lacking under the rule of Illinois Brick. But they, as I have just argued, are normally less able to detect an antitrust viloation of their remote seller than is the direct purchaser of his immediate seller, so the benefits to deterrence from allowing them to sue are likely to be outweighted by the costs in reducing first purchasers' incentives to sue. A further problem is created when the indirect purchasers who bring suit are a class of consumers; and normally they will be, since an effective passing-on defense (implied, as I have suggested, by giving indirect purchasers a right of action) will reduce the incentive to sue, often below the threshold at which litigation is attractive, of all but the ultimate consumer. As I have argued elsewhere, the lawyers who represent class-action plaintiffs lack adequate incentives to press for the largest possible judgment, even in meritorious cases. Their self-interest is often served better by agreeing to a settlement that provides for a relatively small judgment but large attorney's fees, a settlement result also attracive to defendants.' And the individual class members' stakes are too small to give him any incentive to supervise the lawyer for

See my An Economic Approach to Legal Procedure and Judicial Administration, 2 J. Leg. Studies 399, 440 (1973). If that probability is less than one, the judgment should be larger than the estimated social costs of the violation so that the expected cost of punishment to the antitrust violator will equal the estimated social costs. This is the economic rationale of trebling. Actually, the overcharge paid by the purchaser understates the social costs of the antitrust violation. It ignores both the injury to those who stop purchasing the product because of the price increase and the possibility that the antitrust violation may have raised the costs as well as price of the violators. These refinements do not affect the point being made here.

No one seems to think that imposing multiple liability (multiples of three, that is) on the antitrust violator is an acceptable solution. There is such a thing as overdeterrence. See Posner, supra note 3, at 440-41. For empirical support for this proposition see Andrew Rosenfield, "An Empirical Test of Class-Action Settlement," 5 J. Leg. Studies 113 (1976), finding that attorneys' fees in antitrust class actions are inversely related to the size of the settlement. That is, the smaller the settlement, the larger the attorneys' fees, which is suggesive of the kind of "deal" that I worry about in such actions.

the class. This is not to say that the consumer class action has no deterrent effect only that its deterrent effect may be less than that of first-purchaser suits. It has been argued that the first purchaser will often be reluctant to sue his supplier lest an ongoing relationship beneficial to the purchaser be disrupted. The number of private antitrust cases being filed these days, mostly by direct purchasers, leads one to question this asertion. The argument also overlooks the fact that the direct purchaser's acquiescence in his seller's antitrust violations will normally be a compensated acquiescence. A rational profit-maximizing firm will not abandon a legal right worth X million dollars unless it receives concessions of equivalent value to it. From the standpoint of deterring antitrust violations, these concessions constitute a form of antitrust damages. If a supplier wants to buy his purchasers' silence, the price he will have to pay is, in effect, his punishment for the illegal activity that he is trying to conceal.

3. There is another objection to the indirect-purchaser suit besides its effect in reducing the overall deterrent impact of private antitrust suits; the uncertainty and cost involved in trying to trace the incidence of a price increase throughout the entire chain of distribution. This process requires knowledge of the elasticity of the market demand, the slope and height of the demand curve, the shape and level of the market supply curve, and the impact of a price increase on the purchaser's marginal costs. The estimation of these parameters by the methods of litigation is exceedingly difficult.

When a firm is charged a higher price for one of its inputs, it experiences an increase in its costs, and it will try to offset the increase by raising its price. If its competitors are not affected by the cost increase, this attempt will fail, and the firm will either go out of business or it will contract its output if by so doing it can lower its costs. In the latter case, i.e., reduced output, the firm will demand fewer inputs, and the suppliers of those inputs may therefore be hurt, depending on whether they have equally good alternative uses for the resources used to produce these inputs. Tracing the effect on suppliers is complicated by the fact that some may actually benefit: those who supply inputs that are substitutes for the input whose price to the firm has risen as a result of the antitrust violation.

In the more typical case, the increase in the price of the input affects not a single firm but an entire industry, i.e., all the sellers of a product and its close substitutes. Because customers can't in this case turn to the supplier of a close substitute, they will be forced to pay a higher price; i.e, the market price will rise. The market price will probably not rise by the entire size of the sellers' cost increase; for assuming that the sellers are competitive and that their costs would be somewhat lower at a reduced level of output, a market price increase of that magnitude would result in the seller's pricing their output at a price in excess of their costs. The competitive equilibrium will involve, however, a higher price than before the cost increase and a smaller output, resulting in additional costs to both customers and (possibly) suppliers-in other words, in passing onwith again the wrinkle that suppliers of inputs that can be substituted for the input whose cost has risen will obtain a possibly offsetting benefit from that cost increase.

The situation where all sellers of the product and its close substitutes are affected by a rise in the price of an input is illustrated in figure 1. The price increase raises the purchasing industry's marginal-cost curve from MC to MC. This causes the industry to readjust its price and output, thereby shifting part of the cost of the price increase forward to its purchasers and part backward to suppliers of specialized resources. Notice that if all of the specialized resources used in the industry's production are owned by strangers to the firm (landlords or whoever) the industry's shareholders will suffer zero damage from the price increase.10 Identifying the owners of the specialized resources and estimating the wealth effects on them (a question further complicated by the nature of the contractual relationship between supplier and firm) is itself a formidable task.

8 Two additional points are (1) that the corporation that fails to press a valid antitrust cause of action would expose itself to a shareholders' derivative action, and (2) that the seller who retaliated against a purchaser for bringing an antitrust suit would thereby increase the purchaser's damages-as well as strengthen the purchaser's evidence of an antitrust violation.

If resources are not specialized, suppliers can be definition shift them to equally remunerative uses if demand in one industry falls as a result of a contraction in the industry's output. Note that Figure 1 conceals the possible shift of business to suppliers of substitute inputs discussed in the text.

10 In these circumstances, allowing indirect purchasers to sue will, via the passing-on defense, prevent recovery of the full social costs of the antitrust violation. The direct purchasers will not be able to recover any damages; nor will the injured suppliers, because of the rules of standing.