How and why Staples/Office Depot declined to defend their merger against the FTC in court
“Your Honor, I’m sorry to interrupt, Ms Reinhart. Your Honor, maybe I can save the court and counsel time. It’s going to be the defendants’ position that we’re going to rest on the record as it exists, so there’ll be no need for additional evidence or rebuttal.” – Lead Staples attorney Diane Sullivan to Judge Emmet Sullivan
In an announcement that stunned the courtroom – and more or less anyone who had been following the trial – Diane Sullivan, the Weil Gotshal & Manges partner known for her prowess as a litigator, said the defence was resting its case without putting on a single witness or economic expert. The Staples team chose to let a federal judge with a history of siding with the government on antitrust cases decide the fate of its office supplies merger with Office Depot, solely based on the Federal Trade Commission’s case-in-chief.
The FTC has come “woefully short” of meeting its burden, including the crucial question of defining a relevant product market, Diane Sullivan told Judge Sullivan (a name coincidence that created confusion for reporters and readers alike). The defence argued that the FTC had done such a poor job at showing the merger would harm competition that it did not deserve the preliminary injunction it sought – one that the merging parties had admitted would doom the tie-up. In fact, preliminary injunctions, which open the door for lengthy administrative proceedings before an FTC in-house judge, typically spell the end of any deal, regardless of its size or the parties’ urgency to merge.
Why the decision to rest shocked so many people – academics, economists and lawyers – is because the standard to obtain a preliminary injunction is not particularly high, especially for the FTC in the spring of 2016. The defendants made the stakes clear by insisting to Judge Sullivan that if he sided with the government and issued a preliminary injunction, they would scrap the deal. For business reasons, the companies would not be able to withstand a drawn-out proceeding at the commission’s administrative court.
So, knowing that the trial before Judge Sullivan would determine the life or death of a merger the companies argued was crucial to their futures, what prompted their legal team to take the risk? Why did Staples believe the FTC’s case – and the perceived flaws in it – was enough to save their merger?
While not putting on a defence was an unprecedented move during a preliminary injunction hearing in a merger case, the tactic has been used in courtrooms before. Indeed, the companies had multiple opportunities to defend their deal. Diane Sullivan made a compelling opening statement that identified a potentially fatal flaw in the government’s case – that in the FTC’s bid to block the deal, it crafted a market definition that was too narrow and specific to actually exist.
“If I stood in the corner of the courtroom, I’d be the prettiest girl in the corner. But as everybody can see, that’s not much of a market,” she said in court – an analogy blasting the FTC’s expert for what the companies believed was an overly-restrictive view of the market.
Both parties and outside observers knew market definition would be a hard-fought issue throughout the trial. Ms Sullivan said the commission had sued to protect the largest, most powerful companies on earth, which pay far less for the office supplies than retail customers in stores. In looking at the business-to-business office supplies market – and specifically only looking at buyers in the Fortune 100 and at products such as pens and paper – the FTC had drawn a preposterously narrow market to “gin up” the power of Staples and Office Depot, she argued.
As Ms Sullivan reiterated when she announced that the defence would rest without putting on a case, the defendants felt they had damaged the FTC’s case so severely that there was no way Judge Sullivan could rule against them.
Part of what gave them that confidence was the commission’s decision to exclude printer ink and toner from the relevant market, an issue that the parties raised several times throughout the trial. Just two years before the commission sued to block the merger, its commissioners voted unanimously to include ink and toner when examining, and ultimately clearing, the Office Depot/OfficeMax deal. If the FTC had included those two products when crafting its market definition in Staples/Office Depot, the defence felt it would have diluted the companies’ alleged market shares so substantially that the merger would no longer be presumed unlawful under the US merger guidelines.
The FTC has never won a preliminary injunction in a merger case without first establishing that the deal would cross that threshold of presumption. In the eyes of the companies and their lawyers, the agency failed to reach that threshold in this case as well, despite FTC expert and former antitrust enforcer Carl Shapiro insisting that Staples and Office Depot would still dominate the office supply industry even if he had included ink and toner in the affected market.
The exclusion of the products did not match the reality of the market, Diane Sullivan argued in her cross-examination of Shapiro. She said no one that operates in the business would define the market as Shapiro and the FTC had; about 90% of buyers say they want ink and toner included in the product bundles they buy from their office supply vendor. Even Judge Sullivan seemed sceptical about the decision to exclude ink and toner, asking Shapiro at what point in time had the government told him to exclude the products from his expert analysis. “I think the record was pretty clear that he formed his expert opinion after the complaint was filed,” Judge Sullivan said at the end of the hearing. “It would seem to me that the complaint would be based on the expert’s opinion.” Despite FTC trial lawyer Tara Reinhart’s insistence that the government left ink and toner out of the analysis because they are not subject to the same competitive conditions, the defendants felt the products’ absence from the FTC’s defined market shattered the government’s case – so much so that they declined to put on a case of their own.
Looming over the merger challenge was the powerful online retailer Amazon or, more specifically, the prospect that Amazon would begin selling bulk office supplies to major corporate buyers and snatch market share from the merging office supply stores. Sullivan, the defence lawyer, at one point referred to Amazon’s entry into the business-to-business office supply market as an “earthquake”. In her opening statement, she harkened back to the FTC’s 2004 block of the merger between video rental stores Blockbuster and Hollywood Video, which both struggled after not being allowed to join forces. She said the FTC had “tunnel vision” then and in the current case; that the commission was unable to see how innovative online competitors – Netflix in that case and Amazon here – would revolutionise a market that the incumbents had once dominated.
Again, the defence believed that on this point there was no need to put on a case. The government had called Amazon Business vice president Prentis Wilson to the stand, and Ms Sullivan used her cross-examination to cast Amazon’s business-to-business marketplace as a head-on rival and true threat to Staples and Office Depot. She said the company will “transform” the way businesses procure office supplies and other products. At one point, Wilson conceded that Amazon Business offers its customers features beyond the capabilities of the two merging incumbents.
Confident with the effect of Wilson’s testimony, the defence rested before putting on a case – despite Reinhart’s direct examination of Wilson in which he testified that Amazon Business lacks the capacity to provide crucial features that Staples and Office Depot offer, including product curation and desktop delivery. Whether Wilson’s testimony was ultimately good or bad for the government or the merging parties – and whether the defendants showed Amazon to be a significant threat in the industry – had largely been settled during the case-in-chief.
Beyond believing that the government had failed to define a relevant market and that they had shown Amazon to be a competitor, the defendants may also have wanted to minimise risk by resting their case without putting on witnesses.
During a trial, risk comes in many forms, but in this case the uncertainty lay in a slew of emails and memos – “hot” documents – company employees’ internal disclosures of information about the competitive landscape in an industry. Months after the trial, Reinhart, who has since moved back to private practice at Skadden, Arps, Slate, Meagher & Flom, discussed the discrepancies between the communications within Staples and Office Depot, and the defendants’ in-court arguments. There was a sense, at least from the government’s case-in-chief, that the documents might continue to expose weaknesses if the defendants called their own witnesses. The government’s use of such documents in court has become one of the lasting tactical legacies of the Obama administration.
Putting on a defence would have meant bringing Staples and Office Depot executives to the stand, and exposing them to cross-examination. Under a hostile cross, the executives would have been forced to explain documents suggesting that the companies used the spectre of the merger to negotiate prices with buyers – saying that after the deal was closed, prices would go up and there would only be one company with which to deal. They would have to explain documents, under oath, that showed the two companies knew they were the only two companies that supplied bulk office supplies to big corporate buyers. As Reinhart would later note, Staples’ then chief executive Ron Sargent in 2014 gave a speech in which he said the past 20 years had seen the industry consolidate from seven major companies to two, with a significant decrease in regional rivals to boot. The documents appeared to contradict the narrative Diane Sullivan had been trying to push throughout the trial: that there were strong regional competitors, such as WB Mason, in addition to the rising Amazon Business, that could offset competitive concerns.
The documents solidified the government’s case and provided potentially lethal ammunition at trial. There might not have been much – or anything – to gain by putting the executives on the stand; indeed, doing so could have dealt a death blow to the notion that Amazon was a legitimate threat.
Not even an expert?
Perhaps there was a lot to lose by opening up company executives to government cross-examination; perhaps there were no good third-party witnesses that would swing the pendulum drastically in the defence’s favour; but what about an economic expert? Matt Reilly, then a partner at Simpson Thacher & Bartlett and counsel to Office Depot, would say a month after Judge Sullivan’s decision that the defence’s criticisms of Shapiro’s findings and analysis were successfully demonstrated during Diane Sullivan’s cross-examination. He said there was no need to put the defence’s economic expert on the stand.
Reilly said the feeling was that if they had not convinced Judge Sullivan of the government’s faulty market definition by the time the FTC rested, then they were not going to do so during their defence. “If we didn’t have Judge Sullivan by then, we weren’t going to have him,” Reilly said.
But there were things that an economist might have been able to flesh out for a federal judge who, despite having experience presiding over antitrust cases, was admittedly not an expert on the economics of the deal. An expert could have helped counter the way the government supposedly “gerrymandered” the market – the defence repeatedly made that assertion, but perhaps lacked the key voice to explain why the government was wrong. The defence attacked the data, but did not put an expert of their own on the stand to look at the data and explain it in the defence’s terms.
And questions swirled in the months that followed the trial about whether an expert could have helped explain a theory the defence was pursuing: that Amazon was not a potential future competitor, but an existing price constraint; that when Staples would negotiate for a big national customer, the customer would price-check by going on Amazon throughout the life of the contract. Would an expert have been well-positioned to pose that theory, and bridge the gap between having to wait two or three years to fill any lost competition?
When Judge Sullivan’s opinion was delivered, the FTC had done enough to prove its case and the defence had struggled to show that Amazon was a timely, likely and sufficient competitor. The government is not always right, despite a string of litigation successes during Obama’s presidency, but it might be some time before defendants in a merger decline to offer their own case when fighting for their deal in court.