U.S. Judge Rules Apple Colluded on E-Books

Mark Patterson in The Wall Street Journal, July 10, 2013

Media Source

A federal judge found that Apple colluded with five major U.S. publishers to artificially drive up the prices of e-books in the months ahead of its entering the market in 2010. WSJ law reporter Ashby Jones explains the ruling.

Apple Inc. AAPL +0.44%colluded with five major U.S. publishers to drive up the prices of e-books, a federal judge ruled Wednesday in a stern rebuke that threatens to limit the technology company's options when negotiating future content deals.

The ruling—which follows Apple's high-stakes gamble to go to trial even though the publishers settled similar charges—exposes the tech company to as-yet undetermined damages and opens the door for the Justice Department to take a closer look at its other business lines. In settling, the publishers denied wrongdoing.

At issue are the steps Apple took to gain a foothold in e-books for its iTunes online store. The iTunes store is a strategically vital area that accounts for about 10% of Apple's revenue and faces fierce competition from rivals—in particular Amazon.com Inc. AMZN +0.80%Justice Department prosecutors argued that Apple used publishers' dissatisfaction with Amazon's aggressive e-book discounting to shoehorn itself into the digital-book market when it launched the iPad in 2010. Apple's proposal: Let publishers set prices themselves. That led to Amazon losing the ability to price most e-book best sellers at $9.99, causing prices to rise.

In her ruling, U.S. District Judge Denise Cote in Manhattan said the evidence was clear that Apple, despite its claims that it negotiated fiercely and separately with each publisher, was at the center of the conspiracy.

"Understanding that no one publisher could risk acting alone in an attempt to take pricing power away from Amazon, Apple created a mechanism and environment that enabled them to act together in a matter of weeks to eliminate all retail price competition for their e-books," she wrote in a 160-page decision.

Apple said it did nothing wrong and said it plans to appeal. "Apple did not conspire to fix e-book pricing and we will continue to fight against these false accusations," an Apple spokesman said. "When we introduced the iBookstore in 2010, we gave customers more choice, injecting much needed innovation and competition into the market, breaking Amazon's monopolistic grip on the publishing industry.

"Consumers won't see changes in e-book prices as a result of the ruling. Prices of many best-selling titles had already come down after the major publishers settled.

Apple executive Eddy Cue arrived at court to testify in the case last month.

Apple's decision to fight the Justice Department underscores the stakes in the case. The company makes most of its money selling iPhones and iPads. But its iTunes service has become a central part of its offering with huge volumes of electronic content enticing people to buy and upgrade Apple products.

The company has been an aggressive bargainer, successfully opening up new markets for electronic content, most notably with music. But the ruling raises questions about the leverage Apple may have when negotiating future content deals.

The Justice Department itself isn't seeking monetary damages but has instead asked the court to adopt a variety of measures to ensure Apple doesn't engage in similar conduct in the future. This includes not entering "most-favored nation" clauses requiring publishers to match competitors' prices in Apple's digital bookstore, and possibly ending the company's practice of charging a 30% commission on books sold through third-party apps in its App Store.

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The judge, who will hold a hearing on those requests, could choose to heavily regulate Apple, legal experts say, potentially slowing deal-making with content partners for new products, such as its long-awaited television. "Under antitrust law, you can not only prevent the unlawful conduct, but also prevent other conduct that can lead to a similar result," said David Balto, former policy director at the Federal Trade Commission.

Because Apple was found liable for violating U.S. antitrust laws, a separate trial on damages will take place in a lawsuit against the company brought by 33 state attorneys general, who are seeking to recover money on behalf of consumers who paid higher prices for e-books. Apple also faces a private class-action suit alleging price-fixing. The private plaintiffs could recover damages from Apple, provided their legal claims are distinct from the states'.

Apple last year separately settled an antitrust case with the European Commission over e-book pricing but didn't admit any wrongdoing.In the ruling, the judge pointed to comments by Steve Jobs, Apple's co-founder and CEO who died in 2011, as "compelling evidence of Apple's participation in the conspiracy."

In emails introduced as evidence, Mr. Jobs seemed to gloat after published reports in January 2010 that Macmillan and Amazon were separately clashing over pricing following the Apple deal. "Wow, we have really lit a fuse on a powder keg," Mr. Jobs wrote in an email from Jan. 30, 2010.

In a group email at Apple the next day, Mr. Jobs said: "We have definitely helped stir things up in the publishing world."

Judge Cote said she wasn't persuaded by testimony from Eddy Cue, an Apple senior vice president who led negotiations with publishers, who argued that his company's only motivation was to get the best deal from publishers.

A federal judge found Apple colluded with five major U.S. publishers to artificially drive up the prices of e-books in the months ahead of its entering the market in 2010. Ashby Jones discusses the details on MoneyBeat. Photo: Apple.

The judge said she believed Mr. Cue was driven in his negotiations by a desire to please Mr. Jobs. "Cue knew that Jobs was seriously ill and that this would be one of his last opportunities to bring to life one of Jobs's visions and to demonstrate his devotion to the man who had given him the opportunity to help transform American culture," Judge Cote wrote.

Mr. Cue didn't respond to a request for comment Wednesday.

When it entered the e-book market in 2010, Apple agreed to shift to a so-called agency model in which publishers, rather than retailers, set the price of e-books. As part of its deals with the publishers, Apple received a 30% commission on each book sold and the publishers had to match the price of Amazon or other competitors if the competitor's price was lower.

Amazon declined to comment.

At the time, Amazon was the dominant player in the market, accounting for between 80% and 90% of all e-book sales. However, the major publishers were concerned that Amazon was selling books at a loss in order to gobble up market share and had threatened to begin withholding some of their most popular books from the online seller.

The odds of reversing the decision and avoiding damages are long, some legal experts said. The outcome may be similar to the Justice Department's lawsuit against Microsoft Corp. MSFT +1.70%The U.S. Court of Appeals for the District of Columbia was constrained by the judge's heavily fact-based opinion and in 2001 upheld many of his inferences, said Keith Hylton, a professor at Boston University's School of Law.

The Apple case could resonate beyond e-books, with broader implications for providers of everything from music to movies. "If you're a tech company and you are looking to aggregate content, you have to be exceptionally conscious about how you talk to your suppliers," said Ankur Kapoor, an antitrust lawyer at Constantine Cannon LLP. "U.S. v. Apple has put these communications under a very fine microscope."Apple has recently shown signs of more flexibility in its negotiations. Many of the terms of Apple's royalty agreements for its radio service, for example, were more generous to the music companies than what rivals, such as Pandora Media Inc., P -0.45%pay.

Apple's reputation appears unharmed, according to Mark Patterson, a professor at Fordham Law School who specializes in antitrust matters and agreed with Judge Cote's ruling. "The consumer response is a big yawn," he said.

Its shares were little changed on the news, dropping less than 1%, to $420.73 on Wednesday. The stock, however, has fallen about 30% in the past year amid concerns that its growth is slowing.