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In re Electronic Books Antitrust Litigation

United States District Court, S.D. New York

March 28, 2014

PENGUIN GROUP (USA) INC., et al., Defendants. THE STATE OF TEXAS, et al., Plaintiffs,

Steve W. Berman, George W. Sampson, Sean Matt, Hagens Berman Sobol Shapiro LLP, Seattle, WA,

Jeff D. Friedman, Shana Scarlett, Hagens Berman Sobol Shapiro LLP, Berkeley, CA, Kit A. Pierson, Emmy L. Levens, Jeffrey B. Dubner, Cohen Milstein Sellers & Toll PLLC, Washington, DC, Douglas Richards, Cohen Milsten Sellers & Toll PLLC, New York, NY, for class plaintiffs.

Robert L. Hubbard, Geralyn J. Trujillo, Linda Gargiulo, Assistant Attorneys General, Antitrust Bureau, New York, NY, for Plaintiffs States, for State of New York, Liaison Counsel for Plaintiff States.

Gabriel Gervey, Kayna Stavast-Piper, Eric Lipman, Assistant Attorneys General, Austin, TX, for State of Texas.

Theodore J. Boutrous, Jr., Daniel G. Swanson, Gibson, Dunn & Crutcher, LLP, Los Angeles, CA, Cynthia Richman, Gibson, Dunn & Crutcher, LLP, Washington, DC, Howard E. Heiss, Edwad Moss, O'Melveny & Myers LLP, Washington, DC, For defendant Apple Inc.


DENISE COTE, District Judge.

Four related lawsuits have been filed against Apple and five publishers[1] for fixing the prices of e-books in violation of Section 1 of the Sherman Antitrust Act, 15 U.S.C. § 1 ("Sherman Act"). One of the actions was filed by the United States of America ("DOJ"). United States v. Apple Inc., 12 Civ. 2826 (S.D.N.Y.) (the "DOJ Action"). A second action was brought by thirty-three states and U.S. territories (the "States"). State of Texas v. Penguin Grp. (USA) Inc., 12 Civ. 3394 (S.D.N.Y.) (the "States' Action"). A third action was brought by private plaintiffs as a class action. In re Electronic Books Antitrust Litig., 11 MD 2293 (S.D.N.Y.). The fourth action, brought by all of the states of the Union except for Minnesota, as well as the District of Columbia and five U.S. territories and possessions, has been settled. State of Texas, et al. v. Hachette Book Grp., Inc., et al., 12 Civ. 6625 (S.D.N.Y.). The DOJ, States, and class have settled with each of the Publisher Defendants.

Apple alone went to trial, and in a bench trial held in June of 2013 in the DOJ's and States' Actions, Apple was found liable. 952 F.Supp.2d 639 (S.D.N.Y. 2013) (the "Liability Opinion"). The States and class are now pursuing damages from Apple; a damages trial is scheduled to occur shortly.

This Opinion is one of two issued today. The other Opinion certifies a class. This Opinion addresses class plaintiffs' and the States' (collectively, "plaintiffs") motions to exclude the opinions of Apple's experts from the trial, as well as from consideration on the class certification motion and pending summary judgment motion.[2]

Apple submits the opinions of two experts, Dr. Joseph Kalt and Mr. Jonathan Orszag. For the reasons set out below, plaintiffs' motions to exclude are granted with respect to Kalt and granted in part with respect to Orszag.


The relevant background facts, as well as the definitions of certain capitalized terms, are set out in today's Opinion deciding class plaintiffs' motion for class certification.[3] Familiarity with that Opinion, as well as with the Court's Opinion of July 10, 2013 determining liability in the DOJ Action and the States' Action, is assumed.

In brief, the DOJ and the States succeeded in proving at trial that Apple conspired with the Publisher Defendants to raise e-book prices in violation of the Sherman Act. The Publisher Defendants were opposed to Amazon's practice of selling many e-book versions of NYT Bestsellers and New Releases for $9.99. Apple was aware of that discontent as it made a decision in late 2009 to see if it could add an e-bookstore to its iPad. Apple planned to launch the iPad at a presentation on January 27, 2010 ("Launch"). Apple approached the Publisher Defendants and during the ensuing negotiations presented them with the means to eliminate Amazon's control over the retail pricing of e-books and to raise e-book prices. Through negotiations that lasted less than two months, Apple engineered the transformation of the e-book marketplace from a model in which the Publisher Defendants sold their e-books to retailers at wholesale prices and the retailer set the retail price, to one in which the Publisher Defendants took control of retail pricing and sold to consumers by making Amazon and Apple, among others, their agents.

The power that the Publisher Defendants acquired through the agency agreements, which Apple executed with each of the Publisher Defendants ("Agreements"), and which the Publisher Defendants imposed on Amazon, had an immediate impact on the prices of the Publisher Defendants' e-books. In the period after early April 2010, when Apple began to sell its iPad - an iPad that launched with Apple's iBookstore - the prices of the Publisher Defendants' e-books increased dramatically.[4] They essentially increased to the pricing caps that Apple had insisted be included in the Agreements. Apple was fully aware that the Publisher Defendants would use their power over pricing to raise prices significantly and it insisted on pricing caps to restrain those price increases so that Apple would not be embarrassed.

The relevant expert reports were filed in support of and opposition to class plaintiffs' October 11, 2013 motion for class certification. Plaintiff's expert, Dr. Roger Noll, submitted a declaration in support of certification on October 11 and a reply declaration on December 18; Apple's experts, Kalt and Orszag, submitted declarations in opposition to class certification on November 15 and sur-reply declarations on January 21, 2014. On December 18, class plaintiffs moved to exclude Kalt's and Orszag's opinions, both from motion practice and at trial. Also on December 18, the States joined class plaintiffs' motion to exclude Kalt's opinions and filed their own motion to exclude Orszag's. These motions were fully submitted on February 4, 2014.

Today's Opinion granting class certification denied the motion brought by Apple to strike Noll's expert opinion. Because it held that class certification was appropriate whether or not Apple's experts' opinions were admissible, it did not decide whether those opinions should be stricken.

Noll, a Professor Emeritus of Economics at Stanford University and a Senior Fellow in the Stanford Institute for Economic Research, constructed a classic and sophisticated model of e-book pricing to determine the effect of price-fixing on the price of any given e-book published by one of the Publisher Defendants. Noll conducted a multivariate regression analysis on transaction records for more than 149 million sales of 1.3 million different e-book titles. His "competitive benchmark" was given by prices prior to the agency period and prices during the agency period of e-books from smaller publishers as well as from Random House prior to early 2011, when Random House adopted the agency model. Controlling for the effects of an e-book title's publisher, age, popularity, genre, and the availability of hardcover and paperback editions, Noll determined the effect of collusion on each of 502 combinations of these variables. For instance, Noll's model calculates that a customer who purchased an e-book of a Penguin hardcover fiction title on the NYT Bestseller list during the agency period paid an overcharge of approximately 29.4%.

Damages calculations for each transaction are straightforward: damages for a given sale are equal to the price paid multiplied by the overcharge for that title's category. In the example above, purchasing the e-book of a Penguin NYT Bestseller for $14.99 would result in damages of $14.99 × 29.4% = $4.41. Subtracting these damages from the actual price reveals the but-for price - that is, the price a consumer would have paid but for the price-fixing. In the example of the Penguin NYT Bestseller, the but-for price is $10.58, that is, $14.99 less $4.41.

In all but 0.2% of transactions, Noll found that price fixing had resulted in an overcharge, amounting to total damages to consumers of just over $280 million. Noll's model has an adjusted R2 of 0.90 - that is, it explains 90% of the variance in prices among e-book titles.[5]

Apple has relied on the opinions given by Kalt and Orszag to oppose the class plaintiffs' motions for class certification and for summary judgment. It seeks as well to rely on these opinions at the upcoming damages trial. Neither Orszag not Kalt, however, conducted their own econometric or statistical analysis of damages. Orszag did, however, re-run Noll's regression analysis using a modified control group and date range.

For the reasons given below, the motion to strike the Kalt's and Orszag's opinions are granted with one exception. Orszag will be permitted to testify regarding his re-running of Noll's regression analysis, assuming that there is an adequate evidentiary basis to support that analysis at trial.


I. Legal Standard[6]

Federal Rule of Evidence 702 grants an expert witness testimonial latitude unavailable to other witnesses, provided that (1) "the testimony is based on sufficient facts or data, " (2) "the testimony is the product of reliable principles and methods, " and (3) "the expert has reliably applied the principles and methods to the facts of the case." Fed.R.Evid. 702. "[T]he proponent of expert testimony has the burden of establishing by a preponderance of the evidence that the admissibility requirements of Rule 702 are satisfied." United States v. Williams, 506 F.3d 151, 160 (2d Cir. 2007). The district court performs the role of "gatekeeper" - ensuring that the proponent has made the necessary showing and that the expert's testimony "both rests on a reliable foundation and is relevant to the task at hand." Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 597 (1993).

In order to be admissible, "[a]n expert opinion requires some explanation as to how the expert came to his conclusion and what methodologies or evidence substantiate that conclusion." Riegel v. Medtronic, Inc., 451 F.3d 104, 127 (2d Cir. 2006), aff'd on other grounds, 552 U.S. 312 (2008). An explanation is necessary because "when an expert opinion is based on data, a methodology, or studies that are simply inadequate to support the conclusions reached, Daubert and Rule 702 mandate the exclusion of that unreliable opinion testimony." Ruggiero v. Warner-Lambert Co., 424 F.3d 249, 255 (2d Cir. 2005) (citation omitted).

While a district court has "broad latitude" in deciding both "how to determine reliability" and in reaching "its ultimate reliability determination, " it may not abandon this "gatekeeping function." Williams, 506 F.3d at 160-61 (citation omitted). "[N]othing in either Daubert or the Federal Rules of Evidence requires a district court to admit opinion evidence that is connected to existing data only by the ipse dixit of the expert." Kumho Tire Co. v. Carmichael, 526 U.S. 137, 157 (1999) (citation omitted).

"[A] trial judge should exclude expert testimony if it is speculative or conjectural or based on assumptions that are so unrealistic and contradictory as to suggest bad faith." Zerega Ave. Realty Corp. v. Hornbeck Offshore Transp., LLC, 571 F.3d 206, 213-14 (2d Cir. 2009) (citation omitted). "Other contentions that the assumptions are unfounded go to the weight, not the admissibility, of the testimony." Id . (citation omitted). "A minor flaw in an expert's reasoning or a slight modification of an otherwise reliable method" does not itself require exclusion; exclusion is only warranted "if the flaw is large enough that the expert lacks good grounds for his or her conclusions." Amorgianos v. Nat'l R.R. Passenger Corp., 303 F.3d 256, 267 (2d Cir. 2002) (citation omitted). This is because "our adversary system provides the necessary tools for challenging reliable, albeit debatable, expert testimony." Id . A "Vigorous cross-examination, presentation of contrary evidence, and careful instruction on the burden of proof are the traditional and appropriate means of attacking shaky but admissible evidence." Id . (quoting Daubert, 509 U.S. at 596).

The Daubert inquiry is "flexible" and "gives the district court the discretion needed to ensure that the courtroom door remains closed to junk science...." Id . And it is "critical that an expert's analysis be reliable at every step, " for "any step that renders the analysis unreliable" renders the expert's testimony inadmissible. Id . (citation omitted).

II. Motion to Exclude Kalt's Opinions

Joseph P. Kalt is the Ford Foundation Professor Emeritus of International Political Economy at the John F. Kennedy School of Government at Harvard University and a senior economist at the economic consulting firm Compass Lexecon. Kalt holds a B.A. in Economics from Stanford University and a Ph.D. in Economics from the University of California, Los Angeles.[7]

Kalt offers three principal criticisms of Noll's model. First, Kalt argues Noll's model is unreliable because (a) book prices exhibit "churning" and "dispersion" that aren't explained by Noll's model; (b) Noll uses four-week average prices[8] and broad genre categories; and (c) the prices of many e-book titles did not rise with the introduction of the agency model, and Noll's damages model indicates that these prices would have fallen (or fallen more) absent the conspiracy. Second, Kalt charges that Noll's model assumes common injury rather than proving it. And third, Kalt states that Noll's model ignores certain features of the but-for world, and accordingly (a) fails to include discounts for benefits consumers may have received, including lower e-reader prices and the increased availability of self-published and free e-books, and (b) wrongly assumes that e-book purchases through the iBookstore and Barnes & Noble would have all occurred in the but-for world through other e-retailers ("e-tailers").

Plaintiffs seek to exclude all of Kalt's opinions, arguing that they are based on five unreliable "subsidiary opinions":

(A) Kalt's finding that 60% of e-book sales in the first month after the agency model was adopted were at or below pre-agency prices;
(B) Kalt's opinion that e-book pricing exhibits no pricing structure, but rather substantial "churning" and "dispersion";
(C) Kalt's opinion that Noll's omission of a variable capturing "buzz" about a title undermines the reliability of Noll's model, as does the breadth of Noll's genre categories;
(D) Kalt's opinion that actual prices were below but-for prices in more than 10 million transactions; and
(E) Kalt's affirmation of Orszag's opinions related to offsets.

For the reasons set out below, Kalt's opinions are excluded in their entirety.

A. Kalt's Analysis of Post-Agency E-Book Sales At Pre-Agency Prices

Kalt opines that the shift by the Publisher Defendants to agency agreements with their e-tailers "demonstrably resulted in large numbers of titles' prices declining." This opinion is unexpected given that a different Apple expert at the liability trial gave completely contrary testimony.

At trial, Apple offered evidence of a dramatic and uniform increase in the prices of the Publisher Defendants' e-books right after they were able to take control of retail prices. The following graph, offered by Apple at trial, demonstrates this effect as it played out at Amazon. It was based on a comprehensive analysis of detailed transaction records undertaken by Apple's expert.

Liability Opinion, 952 F.Supp.2d at 682.

As can be seen from the graph, there is one anomaly. In what is labelled in the graph as "wave 1, " the e-book prices for four of the five Publisher Defendants rose, sharply, in unison the week of April 4. This coincided with the sale of the iPad with an iBookstore. The sudden upturn in the prices of Penguin's e-books, however, lagged behind the upturn in the other Publisher Defendants' e-book prices since Penguin's contract with Amazon did not permit it to take full advantage of the agency model until a few weeks later. Id . A second vertical line marks the steep rise in the Penguin prices at Amazon, as it was able to take total control of the retail prices for its e-books at that distributor.

Despite this graphic illustration of the rise of the Publisher Defendants' e-book prices as they moved to the agency model, Kalt opines that approximately 60% of e-books sold (by volume) in the month following the move to agency were sold at or even below pre-agency prices.[9] The reason for variance in the opinions offered by Apple's experts is not difficult to explain. Kalt made a fundamental error that fatally undermines his analysis: he chose to mislabel a significant number of "postagency" prices as "pre-agency" prices.

Kalt made this error by identifying all prices charged before the date a publisher's last e-tailer moved to the agency model as "pre-agency." Thus, Kalt classifies prices which were indisputably set by the publisher, under the terms of an agency agreement, as "pre-agency prices, " so long as one e-tailer was still selling the same books under a wholesale model. Kalt thereby misclassified hundreds of thousands of prices set by Penguin.[10]

Penguin did not execute an agency agreement with Amazon until June 2, 2010, and began withholding newly released e-books from Amazon as of April 1 (the "withheld titles"). Liability Opinion, 952 F.Supp.2d at 682. In his initial analysis, Kalt classified the price for every Penguin e-book sold through the iBookstore in April and May 2010, and sold on Barnes & Noble's Nook Book Store during that same period, as a pre-agency price even though Penguin had executed agency agreements with those retailers, Penguin was setting the retail prices for those e-books, and Apple and Barnes & Noble were acting as Penguin's agents. Between April 3 and May 28, Kalt concedes that Penguin released fewer than 20% of its new e-books to Amazon and Amazon was largely confined to selling Penguin e-books that had been released on or before March 31 under the wholesale model.

Kalt has admitted that his initial analysis was flawed. He has admitted that he overlooked the fact that the titles withheld by Penguin were only available for sale under agency agreements after April 3. But his revised analysis continues to treat prices for all other Penguin books, including those sold under agency agreements by Apple and Barnes & Noble, as "pre-agency prices" through May 28, since Amazon continued to purchase them from Penguin under the wholesale model.

Kalt fails to justify this gross misclassification. He asserts that, in the abstract, "basic economics... teaches that if a single retailer continues to have pricing authority over a Publisher Defendant's titles, ... then that retailer's pricing decisions would discipline the pricing of that publisher's titles in the marketplace." But, Amazon's ability to impose ...

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