I wrote a short while ago in this column about the Libor case. I write about it again to explain the distinction between “naked restraints of trade” and “ancillary restraints of trade.” Naked trade restraints are presumptively unlawful under the Sherman Act and are always present in any properly condemned per se offense, while ancillary restraints are subject to challenge only under the “structured rule of reason” and even then only when they demonstrably harm competitive processes in a properly defined market.
As I explain below, the Libor case provides an excellent illustration of a “naked restraint of trade,” which, as such, should be condemned with little inquiry on grounds of fundamental antitrust policy. The moment we begin to debate the merits of a particular “naked restraint,” we have ceased to respect the first principles of antitrust law.
Naked Restraints. Strictly defined, a naked restraint is one by which two or more independent economic actors (typically, two or more direct competitors) agree to set their prices or restrict their output for the sake of doing so – that is, for the purpose of generating higher profits rather than in furtherance of a joint venture by which they aim to improve their offerings. Even if they later say that they plan to devote every penny of their increased profits to research and development in order to improve their respective offerings, or to charity for the benefit of orphans, their arrangement is still a naked restraint, done for its own sake, not as an incident to a joint venture by which they aim to streamline or improve their development, production or distribution of products or services.
Only naked restraints should be condemned under a per se rule. See United States v. eBay, Inc., 968 F. Supp. 2d 1030, 1039 (N.D. Cal. 2013) (“[A] market allocation agreement or any other restraint traditionally subject to per se treatment will only be found to be per se illegal if it facially appears to be one that would almost always tend to restrict competition and decrease output, i.e. if it is a naked restraint on trade. In contrast, when a defendant advances plausible arguments that a practice enhances overall efficiency and makes markets more competitive, per se treatment is inappropriate, and the rule of reason applies.”) (internal quotations and citations omitted).
Two Hypothetical Examples. Here are two illustrative examples that, I hope, serve to make the distinction clear: Suppose that two doctors, Dr. Smith and Dr. Jones, are the only two doctors in a small, isolated town called Williamstown. Suppose further that the residents of this town have a strong aversion to traveling to any other community for medical care, or for practical reasons they cannot do so. These circumstances confer market power on Dr. Smith and Dr. Jones: If they act jointly or in tacit collusion, they can raise their prices significantly or impose unwelcome trading terms without fear of losing business – which is to say, Dr. Smith and Dr. Jones collectively wield significant market power in this closed market.
Here is the first hypothetical. Suppose Dr. Smith and Dr. Jones privately agree that both of them will raise their prices from their prior rates to $1000 per patient visit. They proceed to enforce the agreement, perhaps going to some lengths to obscure its existence or to justify the need to charge these rates. This arrangement constitutes a naked restraint of trade. Our two estimable doctors, who are supposed to be direct competitors, have acted in concert to fix their respective prices. They have done so for the sake of avoiding competition with one another on price. Their very purpose is to fix prices and restrict output. This arrangement is therefore a naked restraint of trade and should be condemned as a per se violation of Section 1. Further inquiry into why they chose to fix their prices or the effect of this arrangement on medical services in Williamstown should not even be permitted on grounds of fundamental antitrust policy. See Nat’l Collegiate Athletic Ass’n v. Bd. of Regents of Univ. of Oklahoma, 468 U.S. 85, 100, 104 S. Ct. 2948, 2959 (1984) (“Horizontal price fixing and output limitation are ordinarily condemned as a matter of law under an ‘illegal per se’ approach because the probability that these practices are anticompetitive is so high; a per se rule is applied when the practice facially appears to be one that would always or almost always tend to restrict competition and decrease output. In such circumstances a restraint is presumed unreasonable without inquiry into the particular market context in which it is found.”) (internal quotation omitted).
Here is the second hypothetical. Suppose our two doctors, who wield market power, pool their funds to purchase costly medical equipment, have it installed in a common space for which they both pay, and jointly pay a technician to maintain and operate it. They further agree when each doctor can use the equipment, and that one of them will use it for some procedures while the other will use it for other procedures, so that each can specialize in different kinds of procedures and provide specialized care to their patients. They may even agree on the prices that each will charge for these particular services, so as to ensure that they generate enough funds to pay for the equipment as well as its maintenance and upgrade. Under this second hypothetical, have they engaged in unlawful horizontal market allocation by specifying which procedures each doctor will perform or when each one will perform her work? Have they engaged in unlawful price-fixing? Possibly, but it is unlikely. The one certain thing we can say about the second hypothetical is that the two doctors have employed ancillary restraints of trade, not naked ones. On their face, these restraints are done in furtherance of a joint venture by which they aim to improve their services and even offer services that neither doctor could offer on her own.
The Distinction Between Naked and Ancillary Restraints. Like a naked restraint, an ancillary restraint is commercial restriction or obligation that is jointly imposed by two or more independent economic actors. The difference is that an ancillary restraint is imposed not for its own sake or as an end unto itself, but in furtherance of a collaborative effort by which the collaborators aim to improve their respective or common offerings. Many if not most ancillary restraints are made between commercial suppliers and their commercial customers and are calculated to improve the quality or distribution of their products. Some ancillary restraints are made between direct competitors that have formed a joint venture in order to improve their research and development (product development), production or distribution. Most ancillary restraints do not give rise to any arguable antitrust concern. It sometimes occurs that direct competitors in a joint venture employ both ancillary and naked restraints. The former should never be condemned per se, and the latter always should be.
For example, in our second hypothetical the doctors’ division of tasks and work hours might be found to be reasonably ancillary to their joint venture, while their agreement on prices might be deemed a naked restraint that is masquerading as an ancillary one. Indeed, a joint venture might be merely an elaborate ruse by which direct competitors seek to fix prices at higher rates and allocate markets while offering themselves a pretext for these practices. In some joint ventures, some of the practices are properly deemed ancillary, while others are naked restraints enforced in the name of the joint venture. The issue deserves care.
Generally speaking, ancillary restraints give rise to antitrust concerns only when they are imposed by economic actors that singly or collectively have market power. In my second hypothetical example, the doctors might have acted in good faith and with honest intentions to improve the quality of their care, but their allocation of tasks and setting of prices might prove to be unreasonable restraints precisely because the two doctors have market power, and their ancillary restraints, though well-intentioned, have resulted in higher prices or inferior services that these two doctors could not have successfully imposed in a competitive market. Their market power means that their patients lack the freedom to vote with their feet by seeking medical care elsewhere.
That is why firms with market power must take special care when coordinating business arrangements with others, particularly other direct competitors.
Even so, most ancillary restraints are pro-competitive even when they are practiced by firms that have market power. In nine cases out of ten, our two doctors likely would face no antitrust objection if all they did was pool resources to offer services that neither could offer on her own. Even in the face of a challenge, the doctors would prevail upon showing that their challenged restraints on prices and services legitimately allowed them to offer better services than either could offer on her own, and that no less restrictive restraint could reasonably do so for them.
No antitrust challenge of their joint collaboration to offer these services should be even allowed unless the plaintiff can first meet its stiff burden to make prima facie showings of (1) harm to competition in one or more properly defined relevant markets, (2) its own antitrust injury, and (3) its antitrust standing. Absent direct (and rare) proof of supracompetitive prices or restricted output, the showing of harm to competition requires a showing of market power in a properly defined relevant market, which in turn can be satisfied by proof of a significant or dominant market share in the relevant market that is protected by strong barriers to both entry and expansion. Without these showings, a plaintiff would lack a proper basis to challenge ancillary restraints under the antitrust laws.
The Rule on Naked Restraints. For purposes of this article, it suffices to say that ancillary restraints should not be condemned as antitrust offenses under a per se rule, while naked restraints must be so condemned: Once a commercial practice is properly identified as a naked restraint, its immediate condemnation should ensue without further inquiry. Allowing further inquiry only encourages the offenders and their emulators to attempt similar naked restraints in the future.
This is a real concern in the everyday world. The threat of tacit price-fixing is usually present in highly concentrated markets dominated by a small number of highly efficient producers (i.e., an oligopoly). In such markets, each seller rationally fears death by mutually ruinous price competition that literally leaves all of them begging at the margins. They therefore face an enormous, ongoing temptation to reach tacit agreements with one another not to compete on price and also to discipline offenders that try to sell at lower prices. OPEC is not the only cartel, but the only one that openly discloses its deliberations and procedures. Antitrust authorities should be especially vigilant about tacit collusion among oligarchs that operate in mature, “saturated” markets, unless we wish again to have an economy dominated by oligarchs that overcharge and underserve all of us precisely because none of them faces any genuine competitive threat. Our antitrust laws should reprove rather than indulge the oligarch’s temptation to fix prices and suppress competition. The only proper antidote to an oligarchy that affords stingy profits lies in superior innovation and disruption that allow the innovating competitor to break away from the pack, if only for a short time. It is more competition, not less, that must save the oligarchs from themselves.
The Market-Power Test. The distinction between naked and ancillary restraints is sometimes difficult to draw. Professor Hovenkamp, a leading antitrust scholar, has helpfully offered us a bright-line test: A naked restraint is one “whose profitability depends on the exercise of market power.” See Herbert Hovenkamp, The Antitrust Enterprise: Principle and Execution (Kindle Locations 1404-1405) (Kindle Edition). An ancillary restraint, simply enough, is one whose success does not depend on the market power of its participants, but rather on the soundness of their joint-venture. See id.
This test can be readily applied to the two above examples. Before applying the test, I again point out that in my hypothetical Dr. Smith and Dr. Jones collectively wield market power in the various markets for medical services in Williamstown. They are the only two providers, and the patients in this town strongly prefer not to seek care elsewhere, or cannot do so as a practical matter. If both doctors raise their prices or jointly impose other unwelcome terms, neither will lose much business at all. The patients must submit to the higher fees and other onerous terms that their only available providers have seen fit to impose on them. Acting together, the two doctors have power over their patients – the power to impose higher prices or other unwelcome terms. This is precisely what is meant by the term “market power.”
In our first example, our two doctors’ agreement to raise their prices will work, or so they reckon. They will raise their prices, and in consequence most of their patients will submit to the increase. The success of this venture thus depends on their ability to exercise market power. It is therefore a naked restraint of trade and should be condemned without any further inquiry. (If the plaintiff is a government prosecutor, the case should be over except for the issue of remedies. If the plaintiff is a private litigant, it must also prove its antitrust injury.)
The test is not whether they in fact exercise market power and therefore can successfully impose higher prices or other unfavorable terms, but whether their challenged restraint can be successful only if their market power allows them to impose it. In our first example, perhaps the two doctors will discover that after all their market power was only apparent, not real. Perhaps they will start charging the fixed, higher prices, and in response many patients will begin to obtain alternative medical care from other providers: Their high margins might lure doctors from other regions to set up shop in Williamstown or finally drive many exasperated patients to travel to another region to receive medical care whenever possible.
The issue, then, is not whether the proponents of a trade restraint actually have market power, but whether the long-term success of the restraint depends upon their having market power. This circumstance is the defining characteristic of a naked restraint of trade. Competitors can successfully impose naked restraints only when they sell to captive customers who lack meaningful alternatives.
In the first example, the two doctors’ fixing of prices and refusal to compete against one another would be doomed to failure in a competitive market. Other doctors would soon charge lower prices or offer other inducements to win patients from them. It can work only because most patients in town lack meaningful alternatives. The doctors’ price-fixing is a naked restraint, done solely for the purpose of fixing prices and averting any direct competition between the only two competitors. (Our courts go even further and hold that horizontal price-fixing is always a per se offense, but horizontal price-fixing makes economic sense and is typically practiced only in markets in which the price-fixers reckon they can impose their unattractive prices on captive customers; some of these markets might be niche markets that are very narrow, but they are distinct markets all the same).
Our second example, which concerns the two doctors’ joint use of medical equipment, provides a telling contrast. In this hypothetical, the success of the venture does not depend on whether the two doctors collectively wield market power for the provision of various kinds of medical services in Williamstown. Even if three new medical groups were to set up shop tomorrow in this forlorn and remote town, the doctors’ joint venture might result in a highly successful facility that patients flock to use because of its excellence. The purpose of the restraints, at least on their face, is to permit our two doctors to purchase and use medical devices in order to improve their medical services, not to raise their prices or restrict their output for the sake of doing so – i.e., to improve their profits. These restraints are ancillary in nature, not naked restraints. They should not be condemned under a per se rule, but at most only after a proper inquiry under the “structured rule of reason.”
Indeed, our hypothetical joint venture would be subject to antitrust review, if at all, only because the two doctors exercise market power over medical services offered in Williamstown. Otherwise, the antitrust laws should have nothing at all to say about such an arrangement. (As noted above, a plaintiff should not be permitted to challenge ancillary restraints unless it can make three necessary threshold showings, one of which is a showing of harm to competition in a properly defined market — which in turn usually requires a showing of market power.)
Lastly, it sometimes occurs that two or more direct competitors will conduct a legitimate joint venture, but also agree to impose naked restraints of trade that they carry out in the name of the joint venture, but not in furtherance of its proper aims, which must be to improve the development, production or distribution of their products or services. Professor Hovenkamp opines that the old NCAA case decided by the Supreme Court (and cited above) fit this category very well.
The Libor Case Demonstrably Concerns Naked Restraints. All of this brings us back to the Libor case, the one that Judge Buchwald decided to dismiss on the pleadings without leave to amend. In Libor, the plaintiffs alleged that the defendants were banks that competed against one another to sell derivative contracts directly to plaintiffs and others, and that these banks secretly colluded to rig the Libor rate, which was one component used to set the prices of these derivative contracts. According to the plaintiffs’ challenge, the banks successfully manipulated the Libor rate in order to increase the effective prices of the derivatives in question, and in consequence the plaintiffs paid higher effective prices for these financial products than they otherwise would have done. On this basis, the plaintiffs alleged that the defendant banks had committed unlawful horizontal price-fixing, which is supposed to be a per se violation of Section 1 of the Sherman Act.
More particularly, the plaintiffs in Libor alleged that the leading global banks of our era secretly colluded to rig the Libor rate so that they could make additional profits that ran into the billions of dollars: Had the Libor rate not been collusively rigged by these direct competitors, the plaintiffs and other direct purchasers collectively would have (1) paid billions less when they became obliged to pay money to the banks under these derivatives, and (2) received billions more from the banks when the banks became obliged to pay money to them under these derivatives. Most of the losses apparently resulted from the banks’ underpayment of interest calculated on the basis of depressed Libor rates. 
The allegations in Libor, if assumed to be true, plainly describe naked restraints of trade that must be condemned on their face as a matter of sound antitrust policy. That is, the banks are direct competitors that wield market power in various markets for derivative contracts, and the sole purpose of their concerted price-manipulations was to manipulate their prices in their favor and to the detriment of their customers. This conduct constitutes the imposition of naked restraints of trade. At least, the plaintiffs in Libor have squarely alleged these matters in their well-stated pleadings. (I add that I have no role or any affiliation with any party in this matter and am a disinterested outside observer of the entire controversy).
Dismissing these allegations and refusing to grant leave to amend, Judge Buchwald found that the defendant banks had been engaged in collaborative activity – namely, their necessary collaboration in order to set the Libor rate – so that they could not be condemned for anticompetitive collusion because of any conduct that they took while engaged in this collaborative venture. She might have added for good measure that if a soldier embarks on a peacekeeping mission, he cannot be charged with murder even if he kills someone on purpose and with malicious, premeditated intent, since his role has been to participate in a peacekeeping endeavor. If the analogy seems absurd, the fault lies in the incorrect reasoning in the Libor decision, not the unfairness of the analogy.
This matter has practical repercussions. The Libor ruling, if uncorrected on appeal, will likely encourage cartels around the world to organize nominally collaborative endeavors during which they will agree to impose price-fixing arrangements and other horizontal restrictions of output with absolute impunity under the antitrust laws of the United States. The result would likely be harmful for the global economy and in particular for those who supply or purchase from the price-fixing oligarchs.
The allegations in Libor do not even arguably concern ancillary restraints that deserve a more complete inquiry to determine whether they are reasonable or anticompetitive. They describe price-manipulation secretly and collusively conducted by direct competitors for the purpose of manipulating their prices in order to increase their profits. That is, these allegations fairly describe naked restraints of trade that, if proven to have been practiced, must be condemned as horizontal price-fixing, which remains a per se violation of Section 1.
Even if the derivatives traders who colluded in Libor had rented a luxury yacht and decided during their cruise that all of them would make more lasting contributions to their communities and fund parks and playgrounds around the world, they would have imposed a naked restraint of trade if they had also agreed to manipulate a price formula in order to increase their profits when selling derivative contracts to their customers. Any such agreement, wherever made, and even if made during an ostensibly collaborative undertaking, is a naked restraint of trade – one done for its own sake. As such, it constitutes a per se violation of Section 1 of the Sherman Act.
If we struggle to condemn even such a practice, and if the pleading of this matter no longer even states a claim, then we have lost our way and would greatly benefit from a resounding, unequivocal clarification of the essential principles of antitrust law.
 The Libor rate in question was supposed to reflect the expected borrowing costs in US dollars reported by selected banks to the British Bankers’ Association (the “BBA”). Each bank was supposed to submit its daily estimates to the BBA accurately, independently, and in confidence. The BBA then prepared a composite interest rate that was a weighted average of the submitted estimates. The Libor rate, thus formulated, was then used as a component of the prices for the derivatives at issue. The banks that submitted their estimates included all of the major sellers of derivative contracts. The Libor rate for US dollars has been called “the most important number in the world.”