FTC Approves 'Merger to Monopoly' in Innovation Market

The intersection of intellectual property and antitrust has been the subject of much fanfare over the past decade. The antitrust agencies have held numerous workshops where enforcement officials and practitioners have debated the scope and limitations of antitrust when such principles intersect with IP rights. The most notable work product generated as a result of this focus has been the 1995 Guidelines setting forth antitrust policy for the Licensing of Intellectual Property issued by the Department of Justice (DOJ) and the Federal Trade Commission (FTC).

Relying on the 1995 Guidelines rubric, the FTC in particular, under the leadership of Chairman Timothy Muris over the last 3 years, has made significant policy statements regarding the proper limitations of antitrust in the IP context. The FTC has, for example, brought lawsuits against Rambus for improperly withholding its patents from others, brought suit against Bristol-Myers Squibb for improper Orange Book listings (the mechanism to extend the life of a patent in the pharmaceutical industry to block generic drug entry) of its name-branded pharmaceuticals, and sued Schering Plough, Upsher Smith and American Home Products for improperly allocating markets for certain drugs.

Perhaps one of the most important decisions relating to the intersection of IP and antitrust came on Jan. 13, 2004. In an important — and split — decision that could have far-reaching consequences for transactions involving so-called “innovation markets,” the FTC announced that it would close its investigation of Genzyme's acquisition of Novazyme, two pharmaceutical companies engaged in research and development of Pompe disease, a rare and often fatal condition affecting children. In so doing, the FTC took the unusual step of approving a merger of the only two participants in a research market (a “merger to monopoly”). The FTC's approval of the merger signals that U.S. antitrust enforcement agencies may be prepared to give less rigorous scrutiny to mergers, joint ventures, and license agreements involving “innovation markets.”

Innovation Markets

Traditional antitrust enforcement has centered on markets that focus on production, services or technology. Over the past decade, however, two questions have arisen. Are there separate, cognizable markets in research and development? If so, are such markets properly the concern of the antitrust enforcement agencies? Whether theoretical or actual, such markets have been termed “innovation markets.” The DOJ and the FTC have defined innovation markets as those markets that consist “of the research and development directed to particular new or improved goods or processes, and the close substitutes for that research and development.” U.S. Department of Justice & Federal Trade Commission, Antitrust Guidelines for the Licensing of Intellectual Property (1995), Sec. 3.2.3. Such “innovation markets” are common in areas typically of concern to intellectual property practitioners including high-tech and biotechnology markets, as they often involve R&D resources that will eventually flourish into products that can be patented.

Some argue that it makes no sense conceptually for antitrust law to be concerned with markets in which there are not yet products or sales. This group maintains that there should be no antitrust scrutiny of such markets. Others contend that because the elimination of competition in research and development may have an adverse impact on price or nonprice competition in a future product market, the antitrust enforcement agencies should examine transactions involving innovation markets just as they would those involving traditional markets. In short, the regulation of transactions in markets involving IP that has yet to develop into a tangible product has been an unsettled area of law.

Under the 1992 Horizontal Merger Guidelines issued jointly by the FTC and DOJ, a transaction that results in a significant concentration in a market is presumptively anticompetitive. That presumption can be rebutted only if the parties can demonstrate transaction-specific efficiencies that could not be achieved in a less restrictive manner. The agencies have intimated that a more conservative approach to analyzing transactions in innovation markets is appropriate. In a 1996 report, the FTC concluded that: “economic theory and empirical investigations have not established a general causal relationship between innovation and competition.” Nevertheless, the FTC has routinely employed the Merger Guidelines' rebuttable presumption approach in innovation market mergers, and has blocked or required divestiture of overlapping lines of R&D in several of the same.

The January Genzyme Decision: Merger to Monopoly Approved

In the Genzyme matter, Novazyme and Genzyme were the only two remaining companies engaged in preclinical research related to Pompe disease. The Commission's investigation focused on the transaction's potential impact on the pace and scope of research into the development of a treatment for Pompe disease.

Because Pompe disease is rare, new therapies are covered by the Orphan Drug Act (ODA). Pursuant to the ODA, the first Pompe therapy to win FDA approval will receive market exclusivity above and beyond patent protection for 7 years. Subsequent therapies can break that exclusivity and be brought to market only by clinically establishing superiority over the first therapy. Thus, Congress provided for special IP protection for treatments of such ODA-covered diseases, granting monopoly status for 7 years for companies that develop treatment for such conditions, in order to foster innovation competition.

In a 3-1-1 decision, the FTC held that the even though Genzyme and Novazyme were the only two concerns working on finding a treatment for Pompe disease, they should be allowed to merge. The Commission apparently concluded that the approach of the Merger Guidelines does not apply to innovation markets.

The FTC's New Approach to Innovation Markets

As part of the majority, Muris issued a separate statement (not signed by any other commissioner, meaning that it is persuasive, not binding, FTC policy) concluding that the rebuttable presumption of the Horizontal Guidelines should not apply to innovation mergers. Muris issued the most aggressive statement by a sitting commissioner regarding the viability of innovation markets: “There is no reason to believe, a priori, that a particular merger is more likely to harm innovation than to help it — which is, of course, simply another way of saying that there is no empirical basis for a presumption.” Muris reasoned that attaching the presumption “would have the effect of routinely blocking mergers likely to accelerate innovation.”

Instead, Muris argued that “innovation market analysis should not even be considered unless the number of competitors is very small.” In those cases, like Genzyme, in which there are very few — or no — competitors remaining post-transaction, Muris wrote that the Commission should use a careful and intense factual investigation to determine whether the case is one in which a potential monopolist faces reduced incentives to innovate.

Muris concluded that the combined entity continued to have strong incentives to bring medications to market. Among the facts he found relevant were:

1) Genzyme's agreement to pay certain financial backers of Novazyme substantial contingent progress payments if two products employing Novazyme's technologies were brought to market within specified time limitations. (Muris reasoned that the presence of substantial Novazyme shareholders in pivotal positions within the combined entity made it likely that Genzyme would continue to pursue the Novazyme technologies.)

2) The combined company's decision to allow the CEO of Novazyme, John Crowley, to run the Pompe program even though he had two children of his own with Pompe disease. (Muris hypothesized that allowing Crowley to run the program (with his personal interest in curing/preventing the disease) was somehow evidence that the combined company would continue to innovate: “It seems unlikely that Genzyme would have given this role to Mr. Crowley if it had wanted to delay the development and introduction of a promising second Pompe therapy.”)

3) The time a litigation against the company would take from the schedule of key executives of Genzyme, which would likely delay the Novazyme research effort.

4) In the more than 2 years separating the merger from the close of the investigation, there was “no evidence that the merger reduced R&D spending on either the Genzyme or the Novazyme program or slowed progress along either of the R&D paths.”

In conclusion, Muris stated: “The Commission's investigation properly focused on how the transaction would affect the pace and scope of research into pharmaceutical products for a life-threatening medical condition affecting infants and young children for which no treatment presently exists. The facts of this matter do not support a finding of any possible anticompetitive harm. Moreover, on balance, rather than put patients at risk through diminished competition, the merger more likely created benefits that will save patients' lives.”

Dissenting Views

In his separate dissenting statement, Commissioner Mozelle Thompson disagreed with Muris, stating that “[t]he Genzyme/Novazyme merger constitutes a consummated merger to monopoly in the research and development of a highly specialized drug, and entry of a new market participant is not likely to replace the innovation competition eliminated by the merger.”

Thompson concluded: “[P]rotecting innovation competition has been a Commission success story over the past decade. Our actions have directly benefited competition and consumers, and these actions have sent a strong signal of support to innovators. In this matter, the failure to issue a complaint may lead the marketplace to draw a different conclusion.”

Commissioner Pamela Jones Harbour abstained on the grounds that she joined the Commission when it was in the final stages of analyzing the merger. Nonetheless, she took the opportunity to issue a separate statement in which she strongly criticized the outcome of the investigation and suggested that a rebuttable presumption of anticompetitive effects should apply to mergers to monopoly in innovation markets. The commissioner noted some interesting facts concerning the merger's effects on the market. She pointed out that prior to the acquisition, Novazyme projected reaching clinical trials at the end of 2001. After the acquisition, Genzyme projected reaching a product launch of 2011, a 10-year difference.

Consequences of the FTC Decision on Innovation Merger Analysis

In finding the rebuttable presumption of the Merger Guidelines inapplicable to innovation competition mergers, even in highly concentrated markets, Muris signaled that the FTC may be prepared to allow substantial consolidation in innovation markets where the parties can demonstrate merger-specific efficiencies designed to enhance consumer welfare. Moreover, Muris' lengthy recitation of the factual underpinnings of the transaction suggests that mergers structured with a view to providing incentive for R&D may better withstand the “careful, intense factual investigation” (FTC Staff Report, “Anticipating the 21st Century: Competition Policy in the New High-Tech, Global Marketplace”, Vol. I, ch. 7, at 18 (1996)) the Commission deems appropriate in such cases.

Parties merging innovation operations (or working jointly through a joint venture, for example) should expect less antitrust scrutiny than those simply combining product market operations. The Commission seems more amenable to efficiency arguments, and certainly will look to the possibility of the strength of combined R&D as a significant factor in its analysis.

In this instance, the perceived benefits of combining operations in the development of crucial IP won out over the significant antitrust concerns raised by the merger. IP practitioners should be cognizant that the FTC may be taking the handcuffs off of competitors seeking to work together to develop new technologies, even where such cooperation may limit the number of independent participants in a market.

The intersection of intellectual property and antitrust has been the subject of much fanfare over the past decade. The antitrust agencies have held numerous workshops where enforcement officials and practitioners have debated the scope and limitations of antitrust when such principles intersect with IP rights. The most notable work product generated as a result of this focus has been the 1995 Guidelines setting forth antitrust policy for the Licensing of Intellectual Property issued by the Department of Justice (DOJ) and the Federal Trade Commission (FTC).

Relying on the 1995 Guidelines rubric, the FTC in particular, under the leadership of Chairman Timothy Muris over the last 3 years, has made significant policy statements regarding the proper limitations of antitrust in the IP context. The FTC has, for example, brought lawsuits against Rambus for improperly withholding its patents from others, brought suit against Bristol-Myers Squibb for improper Orange Book listings (the mechanism to extend the life of a patent in the pharmaceutical industry to block generic drug entry) of its name-branded pharmaceuticals, and sued Schering Plough, Upsher Smith and American Home Products for improperly allocating markets for certain drugs.

Perhaps one of the most important decisions relating to the intersection of IP and antitrust came on Jan. 13, 2004. In an important — and split — decision that could have far-reaching consequences for transactions involving so-called “innovation markets,” the FTC announced that it would close its investigation of Genzyme's acquisition of Novazyme, two pharmaceutical companies engaged in research and development of Pompe disease, a rare and often fatal condition affecting children. In so doing, the FTC took the unusual step of approving a merger of the only two participants in a research market (a “merger to monopoly”). The FTC's approval of the merger signals that U.S. antitrust enforcement agencies may be prepared to give less rigorous scrutiny to mergers, joint ventures, and license agreements involving “innovation markets.”

Innovation Markets

Traditional antitrust enforcement has centered on markets that focus on production, services or technology. Over the past decade, however, two questions have arisen. Are there separate, cognizable markets in research and development? If so, are such markets properly the concern of the antitrust enforcement agencies? Whether theoretical or actual, such markets have been termed “innovation markets.” The DOJ and the FTC have defined innovation markets as those markets that consist “of the research and development directed to particular new or improved goods or processes, and the close substitutes for that research and development.” U.S. Department of Justice & Federal Trade Commission, Antitrust Guidelines for the Licensing of Intellectual Property (1995), Sec. 3.2.3. Such “innovation markets” are common in areas typically of concern to intellectual property practitioners including high-tech and biotechnology markets, as they often involve R&D resources that will eventually flourish into products that can be patented.

Some argue that it makes no sense conceptually for antitrust law to be concerned with markets in which there are not yet products or sales. This group maintains that there should be no antitrust scrutiny of such markets. Others contend that because the elimination of competition in research and development may have an adverse impact on price or nonprice competition in a future product market, the antitrust enforcement agencies should examine transactions involving innovation markets just as they would those involving traditional markets. In short, the regulation of transactions in markets involving IP that has yet to develop into a tangible product has been an unsettled area of law.

Under the 1992 Horizontal Merger Guidelines issued jointly by the FTC and DOJ, a transaction that results in a significant concentration in a market is presumptively anticompetitive. That presumption can be rebutted only if the parties can demonstrate transaction-specific efficiencies that could not be achieved in a less restrictive manner. The agencies have intimated that a more conservative approach to analyzing transactions in innovation markets is appropriate. In a 1996 report, the FTC concluded that: “economic theory and empirical investigations have not established a general causal relationship between innovation and competition.” Nevertheless, the FTC has routinely employed the Merger Guidelines' rebuttable presumption approach in innovation market mergers, and has blocked or required divestiture of overlapping lines of R&D in several of the same.

The January Genzyme Decision: Merger to Monopoly Approved

In the Genzyme matter, Novazyme and Genzyme were the only two remaining companies engaged in preclinical research related to Pompe disease. The Commission's investigation focused on the transaction's potential impact on the pace and scope of research into the development of a treatment for Pompe disease.

Because Pompe disease is rare, new therapies are covered by the Orphan Drug Act (ODA). Pursuant to the ODA, the first Pompe therapy to win FDA approval will receive market exclusivity above and beyond patent protection for 7 years. Subsequent therapies can break that exclusivity and be brought to market only by clinically establishing superiority over the first therapy. Thus, Congress provided for special IP protection for treatments of such ODA-covered diseases, granting monopoly status for 7 years for companies that develop treatment for such conditions, in order to foster innovation competition.

In a 3-1-1 decision, the FTC held that the even though Genzyme and Novazyme were the only two concerns working on finding a treatment for Pompe disease, they should be allowed to merge. The Commission apparently concluded that the approach of the Merger Guidelines does not apply to innovation markets.

The FTC's New Approach to Innovation Markets

As part of the majority, Muris issued a separate statement (not signed by any other commissioner, meaning that it is persuasive, not binding, FTC policy) concluding that the rebuttable presumption of the Horizontal Guidelines should not apply to innovation mergers. Muris issued the most aggressive statement by a sitting commissioner regarding the viability of innovation markets: “There is no reason to believe, a priori, that a particular merger is more likely to harm innovation than to help it — which is, of course, simply another way of saying that there is no empirical basis for a presumption.” Muris reasoned that attaching the presumption “would have the effect of routinely blocking mergers likely to accelerate innovation.”

Instead, Muris argued that “innovation market analysis should not even be considered unless the number of competitors is very small.” In those cases, like Genzyme, in which there are very few — or no — competitors remaining post-transaction, Muris wrote that the Commission should use a careful and intense factual investigation to determine whether the case is one in which a potential monopolist faces reduced incentives to innovate.

Muris concluded that the combined entity continued to have strong incentives to bring medications to market. Among the facts he found relevant were:

1) Genzyme's agreement to pay certain financial backers of Novazyme substantial contingent progress payments if two products employing Novazyme's technologies were brought to market within specified time limitations. (Muris reasoned that the presence of substantial Novazyme shareholders in pivotal positions within the combined entity made it likely that Genzyme would continue to pursue the Novazyme technologies.)

2) The combined company's decision to allow the CEO of Novazyme, John Crowley, to run the Pompe program even though he had two children of his own with Pompe disease. (Muris hypothesized that allowing Crowley to run the program (with his personal interest in curing/preventing the disease) was somehow evidence that the combined company would continue to innovate: “It seems unlikely that Genzyme would have given this role to Mr. Crowley if it had wanted to delay the development and introduction of a promising second Pompe therapy.”)

3) The time a litigation against the company would take from the schedule of key executives of Genzyme, which would likely delay the Novazyme research effort.

4) In the more than 2 years separating the merger from the close of the investigation, there was “no evidence that the merger reduced R&D spending on either the Genzyme or the Novazyme program or slowed progress along either of the R&D paths.”

In conclusion, Muris stated: “The Commission's investigation properly focused on how the transaction would affect the pace and scope of research into pharmaceutical products for a life-threatening medical condition affecting infants and young children for which no treatment presently exists. The facts of this matter do not support a finding of any possible anticompetitive harm. Moreover, on balance, rather than put patients at risk through diminished competition, the merger more likely created benefits that will save patients' lives.”

Dissenting Views

In his separate dissenting statement, Commissioner Mozelle Thompson disagreed with Muris, stating that “[t]he Genzyme/Novazyme merger constitutes a consummated merger to monopoly in the research and development of a highly specialized drug, and entry of a new market participant is not likely to replace the innovation competition eliminated by the merger.”

Thompson concluded: “[P]rotecting innovation competition has been a Commission success story over the past decade. Our actions have directly benefited competition and consumers, and these actions have sent a strong signal of support to innovators. In this matter, the failure to issue a complaint may lead the marketplace to draw a different conclusion.”

Commissioner Pamela Jones Harbour abstained on the grounds that she joined the Commission when it was in the final stages of analyzing the merger. Nonetheless, she took the opportunity to issue a separate statement in which she strongly criticized the outcome of the investigation and suggested that a rebuttable presumption of anticompetitive effects should apply to mergers to monopoly in innovation markets. The commissioner noted some interesting facts concerning the merger's effects on the market. She pointed out that prior to the acquisition, Novazyme projected reaching clinical trials at the end of 2001. After the acquisition, Genzyme projected reaching a product launch of 2011, a 10-year difference.

Consequences of the FTC Decision on Innovation Merger Analysis

In finding the rebuttable presumption of the Merger Guidelines inapplicable to innovation competition mergers, even in highly concentrated markets, Muris signaled that the FTC may be prepared to allow substantial consolidation in innovation markets where the parties can demonstrate merger-specific efficiencies designed to enhance consumer welfare. Moreover, Muris' lengthy recitation of the factual underpinnings of the transaction suggests that mergers structured with a view to providing incentive for R&D may better withstand the “careful, intense factual investigation” (FTC Staff Report, “Anticipating the 21st Century: Competition Policy in the New High-Tech, Global Marketplace”, Vol. I, ch. 7, at 18 (1996)) the Commission deems appropriate in such cases.

Parties merging innovation operations (or working jointly through a joint venture, for example) should expect less antitrust scrutiny than those simply combining product market operations. The Commission seems more amenable to efficiency arguments, and certainly will look to the possibility of the strength of combined R&D as a significant factor in its analysis.

In this instance, the perceived benefits of combining operations in the development of crucial IP won out over the significant antitrust concerns raised by the merger. IP practitioners should be cognizant that the FTC may be taking the handcuffs off of competitors seeking to work together to develop new technologies, even where such cooperation may limit the number of independent participants in a market.