The opinion of the court was delivered by: STANLEY SPORKIN
Plaintiff, the Federal Trade Commission ("FTC"), seeks a permanent injunction and restitution or disgorgement under Section 13(b) of the Federal Trade Commission Act, 15 U.S.C. § 53(b). The Commission's complaint charges the defendant, Abbott Laboratories ("Abbott") with engaging in unfair methods of competition in or affecting commerce in violation of Section 5(a) of the FTC Act, 15 U.S.C. § 45(a). This charge stems from Abbott's role in the submission of bids to provide infant formula under the Commonwealth of Puerto Rico's WIC program.
The WIC program is a federal program administered by the Food and Nutrition Service ("FNS") of the Department of Agriculture ("USDA"). The WIC program is designed to provide supplemental foods (including infant formula) and nutrition education to women, infants and children (up to their fifth birthday) who have income level so low as to put them at nutritional risk. 42 U.S.C. §§ 1786-1788 (1988). WIC is funded by the federal government, but the implementation of the program is left to the states. Puerto Rico is treated like a state for WIC purposes and it administers its own WIC program through the Puerto Rico Department of Health and its procurement division, known as AFASS.
The FTC complaint alleges that Abbott, the largest producer of infant formula in the United States, conspired "to fix, stabilize, or otherwise manipulate" the bids to supply infant formula to the Puerto Rican WIC program. Complaint P12. The complaint also alleges that Abbott "with anticompetitive intent or without an independent legitimate business reason, provided information that showed to competing bidders that defendant preferred, and would bid in a manner to support, an open market instead of a sole source system [of infant formula procurement for the WIC program] in Puerto Rico." Complaint P 13. Thus the complaint makes two separate allegations. The first is that Abbott conspired with others to "rig" the bids to supply formula under Puerto Rico's WIC program. The second allegation is that Abbott acted unilaterally (without necessarily agreeing with others) to obtain an anticompetitive outcome in the bid.
Infant Formula and the WIC Program
In 1990, Abbott, through its infant formula division Ross Laboratories accounted for more than 50% of U.S. infant formula sales. Between 1982 and 1990, Abbott and its two principal competitors, Mead Johnson & Company ("Mead"), and Wyeth Laboratories ("Wyeth") accounted for over 90% of domestic infant formula sales. The infant formulas produced by Abbott, Mead, and Wyeth are substantially similar in nutritional quality. Despite this similarity, new mothers generally continue to purchase and feed their babies the same brand of formula that was supplied to the baby in the hospital.
In Puerto Rico, the WIC program provides infant formula to approximately two-thirds of the infant population. This compares to a national average of about one-third. Puerto Rico is one of the nation's most important WIC markets. Puerto Rican WIC participants receive their infant formula through retail channels. Wholesalers buy formula from the manufacturers for resale to retailers or other distributors. The retailer sells infant formula off the shelf to WIC program recipients who pay for the formula with coupons or vouchers received from the local WIC agency. The retailer then sends the coupons to the state WIC agency for payment.
The bids submitted for the WIC infant formula contract are in the form of rebates (per can of formula) to the state. The rebates obtained by the WIC programs from the infant formula manufacturers are used by the state WIC program to fund purchases of infant formula and other food products for additional needy persons. The saving from these "cost containment" measures is crucial because funding for WIC does not fully cover the cost of the program.
Nationally, only slightly more than 60 percent of the eligible population participates in WIC. In simple terms, there is not enough federal money to feed all the mothers and children who meet the qualifying criteria. By implementing cost containment measures, state WIC agencies have been able to use the saved money to serve a larger percentage of the eligible population than would have otherwise been possible. Approximately 23% of the 6.5 million people who receive food under the WIC program nationally, receive it because of funds that have been made available through manufacturers' rebates.
There are two different kinds of cost containment systems that have been implemented by states in trying to reduce the cost of the WIC program. One cost containment system is the "open market system." In an open market system, all suppliers are eligible to participate in the WIC market whether or not they offer a rebate. They compete for consumer patronage much as they do in the private sector of the market.
The other cost containment program is referred to as the "sole source system."
Under a sole source system, a state's WIC program selects the supplier after soliciting sealed bids from all eligible and interested manufacturers.
The manufacturer offering the lowest net cost per unit (or highest rebate per unit) of infant formula is awarded the sole source contract for the entire state. Under the sole source system, only the winning bidder is permitted to supply infant formula to the state's WIC mothers. Federal regulations create a strong preference for a sole source system and companies wishing to participate are required to submit sealed competitive bids.
Under the sole source system, the manufacturer is given a monopoly in that particular state. The possibility of obtaining an exclusive business arrangement means that formula manufacturers generally offer higher rebates under a sole source procurement than under the open market non-exclusive system. Conversely, under the open market system, manufacturers pay smaller rebates because they are not guaranteed a WIC monopoly. The smaller rebate paid under the open market system means that manufacturers may make more money under the open market system than under a sole source procurement. Although market share is maximized under the sole source, profits may be reduced because of the larger rebate payment.
A state may implement an open market system without USDA approval only where the savings that would accrue to the WIC program through open market rebates are equal to, or greater than, the savings under the highest sole source bid. 7 C.F.R. § 246.16(m). If the savings to the state under the open market option are less than the savings from the sole source option, the state WIC agency must obtain a waiver from the USDA to implement an open market system.
Such waivers are granted only in very limited circumstances where the difference in savings between the two systems is marginal. Once the WIC bidding is complete, the state WIC agency must submit a bid analysis for USDA review and approval.
Infant Formula and the Hospital System in Puerto Rico
In addition to administering the Puerto Rico WIC program, AFASS, the Puerto Rican Department of Health's procurement division, maintains and operates eight public hospitals throughout Puerto Rico. Approximately 23,000 "WIC babies" are born in these hospitals each year. Another 20,000 "WIC babies" are born in non-AFASS government hospitals and private hospitals in Puerto Rico. Abbott, Mead, and Wyeth are the principal suppliers of infant formula to these hospitals, AFASS and non-AFASS alike. Prior to 1990 each of these three companies made cash payments to the government hospitals and supplied free formula to them for in-hospital feeding and for distribution, in "take home packs" to new mothers. Since it is known that mothers prefer feeding their children the brand of formula they received at the hospital, these payments are a key part of the manufacturers' marketing plans to increase market share in the Puerto Rican infant formula market generally and the WIC market in particular.
There was testimony at trial that the Puerto Rican state hospital system was experiencing financial difficulties in 1990. The payments by formula makers were important to the Puerto Rican hospital system as they generated on the order of two million dollars annually in discretionary income for the government hospitals. These extra payments were not subject to the control of the USDA and the monies generated by these payments were not allocated to the WIC program.
So, there are two different infant formula supply systems interacting in this case. The first is the AFASS hospital supply system in which formula is provided free of charge to AFASS hospitals, along with payments of money and equipment. The second is the WIC rebate program. These systems interact in that both are administered by the Puerto Rican government. The hospital supply system is used by the manufacturers to increase their market share of the wider infant formula market, including the market for WIC babies.
Tension arises from the fact that under a sole source WIC supply system, the marketing benefits that accrue to hospital program formula suppliers are undermined. Under the sole source system, upon discharge from the hospital, all WIC infants born in AFASS hospitals would have access only to the formula supplied by the sole source supplier. Money spent by the manufacturers to promote their brand of formula in the hospital would be wasted under a sole source system, because WIC mothers would be limited to the "sole source" brand of formula on leaving the hospital.
During the 1990 WIC bid, it was understood by all the formula manufacturers that payments to the AFASS government hospitals would continue only under an open market WIC rebate system. Partly because the Puerto Rican hospital system would lose the substantial side payments from manufacturers which the hospitals used to buy equipment and other supplies, AFASS wanted an open market WIC rebate system in Puerto Rico. This was particularly so since any unspent Puerto Rican WIC funds would be reallocated from Puerto Rico to other WIC programs. Money paid to the Puerto Rico hospitals directly was more likely to stay in Puerto Rico than excess WIC rebate funds. Abbott and the other formula providers knew of Puerto Rico's preference for an open market system.
Prior to June 1990, each of the AFASS hospitals contracted separately with an infant formula company to select it as the supplier of formula for use by babies staying in that hospital. In the spring of 1990, the director of AFASS decided to centralize these hospital formula supply arrangements by adopting what is referred to as the hospital rotation system. Under this supply system, the nine AFASS hospitals were divided into three groups. Each company was offered the opportunity to supply free formula to one hospital group and to rotate as the supplier to the other two groups in each of the two succeeding years, provided the company accepted the terms and conditions of the AFASS hospital supply contract. To participate in the rotation system, the companies had to agree to pay $ 50 per baby to AFASS and to rebate at least 40 cents to the WIC program. This 40 cent minimum was premised on the adoption of an open market system. The request for proposals for the rotation system was announced on June 6, 1990.
Just prior to the public announcement of the "rotation system," AFASS had released the solicitation for bids to supply infant formula under Puerto Rico's WIC program. The bidding was to be conducted under the so-called "Florida model" of bidding. Under the Florida model, the companies could submit bids for either the sole source option, the open market option, or both. Again, AFASS officials recognized that if a sole source contract resulted from the WIC bid, the $ 50 per infant payments to AFASS would end because neither the winning nor the losing bidders would have any incentive to continue such payments. A pre-bid conference for June 7, 1990 was scheduled.
On June 5, 1990, Puerto Rico officials held a meeting to discuss its proposed "rotation system" to supply infant formula to its hospitals. Abbott representatives who attended the meeting walked out of the meeting when the discussion by Mead and Wyeth turned to the minimum 40 cent rebate specified in the proposed hospital supply contract. The Abbott officials deemed it inappropriate to discuss prices or market allocations in the presence of competitors. This action on the part of Abbott shows that Abbott officials were senstitive to appropriate legal requirements.
On June 7, 1990, AFASS held its scheduled pre-bid conference on the proposed WIC contract. During the conference, the possibility of Puerto Rico's obtaining a waiver of the sole source requirement from the Department of Agriculture was briefly discussed. All company representatives were of the view that the sole source system would not be in the best interests of Puerto Rico. The comments centered around the "unique" nature of Puerto Rico, namely, its isolation from the mainland which made it vulnerable to a cutoff in supply. The Wyeth representative cryptically wrote in his notes, "Rebate, they are all in agreement. Everyone asked for an open market." After the WIC pre-bid conference was ...