At Hedgeye Potomac Research, we consistently keep you up to speed on the investment-relevant actions of Congress and the Executive Branch. But the third branch of government – the federal courts – plays a critical role in establishing the rules of the game for companies and industry sectors.
We are pleased to announce the launching of our new Legal Catalysts vertical, highlighting key cases and legal developments with significant potential impact across multiple sectors. Paul Glenchur, our longtime telecom and media analyst, but also a former federal appellate court law clerk, attorney, and member of the Supreme Court Bar, will lead this research offering. We are happy to provide you a glimpse of Hedgeye Potomac’s “Legal Catalysts.”
We will issue a monthly overview of the cases we're following (like today's overview). As new cases arise and others reach decision, the list will be updated. Separately, we'll discuss each case at pivotal points in their respective proceedings.
We will also highlight important legal trends and developments when they could prove critical to investment outlooks. Please contact sales@hedgeye.com with inquiries or suggestions.
In Legal Catalysts, we are not attempting to provide legal advice or counsel. We are integrating our legal and appellate court background with a market focus to uncover potential opportunities when the "third branch" of government -- the judicial branch -- is making big decisions that could affect particular companies or sectors. For the cases we're following, we will update on emerging developments, our read after crucial oral arguments, decision timing, and likely outcomes.
Initially, we'll focus on five prominent appellate court battles involving:
- The prospect of legalized sports betting across the nation;
- The antitrust challenge to a key component of the American Express business model;
- The high stakes multi-billion dollar copyright battle between Oracle and Google;
- The challenge to the constitutionality of the Consumer Financial Protection Bureau;
- The potential rejection of common carrier regulation of broadband networks.
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Can states legalize sports Wagering? (MGM, WYNN, LVS, CZR, DIS, FOXA, CBS) - The Supreme Court |
Oral arguments could provide meaningful insights, but at this point, we give the edge to the State of New Jersey. For now, Nevada is the only state with legal wagering on major sporting events. New Jersey has challenged a federal law that prohibits the state from repealing its own restrictions on sports gambling. The Supreme Court will hear arguments in this case on December 4. As early as the first quarter of next year, the Court will decide whether the federal prohibition is an unconstitutional usurpation of state sovereignty.
Oral arguments could provide meaningful insights, but at this point, we give the edge to the State of New Jersey.
If the state prevails, the Supreme Court's ruling could encourage interested states to legalize sports betting, generating economic and tax benefits for affected jurisdictions and new revenue streams for gaming interests.
The American Gaming Association, including prominent members like MGM, Las Vegas Sands, Caesars Entertainment, Wynn Resorts and Penn National Gaming, has filed briefs supporting the State of New Jersey. The NCAA, and major professional sports leagues like the NFL, NBA, MLB and the NHL, have opposed New Jersey's bid to legalize sports wagering and asked the Supreme Court to reject the case. The High Court took the case anyway, however, making this a courtroom contest of intense interest.
Media companies and broadcasters that have paid billions to license coveted sports rights (DIS, CBS, FOXA, TWX) could benefit if more expansive sports wagering across the country ultimately intensifies interest in live viewing of high profile sporting events.
* Governor Chris Christie v. NCAA, U.S. Supreme Court. Appeal from the U.S. Court of Appeals for the Third Circuit.
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Can American Express prohibit merchants from steering customers to cheaper credit cards? (AXP, V, MA, DFS) - Supreme Court |
American Express charges merchants higher transaction fees than other credit cards. As a condition of participation in the AmEx card network, the company prohibits merchants from encouraging or enticing customers to use alternative cards like the Discover Card, Visa or MasterCard (the AmEx anti-steering requirement or non-discrimination provisions).
The Justice Department and numerous state attorneys general challenged these anti-steering requirements as a violation of the antitrust laws, arguing the merchant agreements are illegal contracts that foreclose credit card price competition. The Government won at trial but the appellate court reversed, handing American Express a big victory.
Although the Trump Justice Department asked the Court to pass on this case, the Court just announced it will hear it anyway, renewing uncertainty for American Express while offering a potential boost to the usage of other cards.
The testimony of AmEx CEO Ken Chenault underscored the importance of this case: "If we are discriminated against at the point of sale, our business model would be destroyed. The trust in AmEx would be destroyed."
AmEx says the higher merchant fees fund its premium cardholder rewards program. With only 26% of the credit card market, the company asserts the card market is healthy.
The Supreme Court will decide whether the harm to merchants, by itself, is sufficient to justify an antitrust complaint under the Sherman Act. AmEx says when the total affected market includes credit card users as part of a two-sided market, the overall competitive impact is benign or even positive.
Briefs on the merits and subsequent oral arguments will be critical, but at this stage of the proceedings, we give the edge to the states challenging AmEx. The Court may want to simplify the litigation of antitrust cases involving two-sided markets like the merchant/cardholder markets featured here. Despite asking the Court to decline hearing this matter, the Justice Department acknowledges concerns with the Second Circuit's approach.
Retailers also backed Supreme Court review, noting credit card fees often represent the second highest cost of doing business.
The case will likely be argued in the first quarter of next year. A decision should come down by the end of the second quarter.
* State of Ohio v. American Express, U.S. Supreme Court. Appeal from the U.S. Court of Appeals for the Second Circuit.
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Does Google Owe Billions in Java Licensing Fees to Oracle? (ORCL, GOOGL) - Federal Circuit Court of Appeals |
The Federal Circuit specializes in intellectual property cases and this one's a doozy. The court will decide whether Google's use of proprietary Oracle software without a license constitutes "fair use" under the copyright law. Absent fair use, Oracle claims Google owes about $9 billion -- thus far -- in damages.
Three years ago, the Federal Circuit ruled that key parts of Java programming language (application programming interface (API) packages) were protected by copyright and that Google's unlicensed use of these APIs in its Android mobile operating system infringed Oracle's copyright (Oracle acquired Java rights when it acquired Sun Microsystems). Google previously attempted to work out a license agreement for the use of key parts of Java but no agreement was reached. Google relied on several Java APIs nonetheless in launching its Android OS.
The case was remanded to the federal trial court in Northern California and a jury concluded that Google's use of Java constituted fair use. Oracle asked the judge to essentially override the Jury's verdict, but he declined to do so. The case is now back on appeal to the Federal Circuit to determine whether the law of fair use was properly applied in this case.
The accuracy and credibility of Oracle's $9 billion damages assertion have never been litigated because the trial court's rulings have kept the case from reaching the damages phase. If the Federal Circuit rules for Oracle, the case will go back to the trial court for a thorough vetting of Oracle's damages claim. Android is the world's leading mobile operating system. More than 80 percent of smartphones sold to end users (globally) utilize Google's Android operating system.
The probable outcome here is a very difficult call prior to oral arguments. The judges assigned to the panel and the issues they emphasize during arguments should provide more useful indications of the case disposition. The enforcement of licensing obligations, while a big benefit to Oracle, could be disruptive to an ecosystem that runs largely on Java APIs. Oracle also complains the trial court judge made untenable procedural rulings that undermined its case.
Briefing in the case was recently completed. We anticipate oral arguments before a three-judge panel around the end of this year or early next year. A decision could come down around mid-year (2Q or 3Q of 2018).
* Oracle America, Inc. v. Google Inc., U.S. Court of Appeals for the Federal Circuit. Appeal from the Northern District of California.
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Is the Consumer Financial Protection Bureau -- including its enforcement orders -- constitutional? (PHH) - DC Circuit Court of Appeals |
The federal appellate court will soon determine whether the CFPB goofed when it exponentially hiked financial penalties on PHH Corporation (PHH) for alleged violations of the Real Estate Settlement Procedures Act (RESPA). A CFPB administrative law judge proposed a $6 million fine against PHH for asserted "kickbacks" involving an affiliated mortgage reinsurance provider.
The Director of the CFPB, Richard Cordray, disregarded the ALJ and expanded the liability range, imposing a fine (disgorgement order) of $109 million on a company with roughly $700 million in annual revenues.
This case awaits a decision of the full U.S. Court of Appeals for the DC Circuit. The case was argued in late May before an en banc court (all active judges).
A prior three-judge panel rejected the CFPB's interpretation of RESPA and also ruled that CFPB's leadership structure violated the constitution by vesting unchecked power in its Director, Mr. Cordray. Such unchecked and unaccountable power, the court said, violates "separation of power" principles embedded in the Constitution.
An en banc rehearing was granted, lifting the decision of the initial panel and setting the stage for full court review. The full DC Circuit (all 11 active judges) held extensive oral arguments on this case, spending little time on the RESPA holding and focusing completely on the constitutional issues.
At this point, we suspect the court will split on the issue of CFPB's constitutionality and whether Congress, in creating the CFPB as part of Dodd-Frank, empowered its director to make decisions with insufficient accountability, conferring unchecked power on Director Cordray that exceeded the powers of cabinet officials or other heads of independent agencies. The absence of discussion about the RESPA aspects of the case could indicate -- but certainly does not assure -- that the judges are comfortable with the initial court's statutory decision in favor of PHH Corp.
Because the views and opinions of 11 judges are involved, the decision could still be a few months away. For now, we are cautiously optimistic that the ruling will remain favorable to PHH when it is finally released. The constitutional issues will likely head to the Supreme Court.
* PHH Corporation v. Consumer Financial Protection Bureau, U.S. Court of Appeals for the DC Circuit (en banc). Review of an Order of the Consumer Financial Protection Bureau.
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Can the FCC regulate broadband providers as common carrier public utilities? (CMCSA, CHTR, T, VZ, S, TMUS) - Supreme Court |
In its 2015 net neutrality order, the FCC classified broadband access as a public utility common carrier service. This exposed cable operators and telecom carriers to the risk of Internet access price regulation ("just and reasonable" rates) and empowered the FCC to ban paid prioritization over broadband access networks, depriving ISPs of the opportunity to diversify revenue streams through deals with upstream content and service providers.
The FCC's common carrier classification was upheld by the DC Circuit and petitions seeking to reverse that decision have just been filed in the Supreme Court.
Because the FCC, now under Republican leadership, wants to repeal common carrier broadband regulation, the Supreme Court may reject the case as essentially moot when that anticipated order is released around the end of the year. Despite this, the case is worth monitoring because if the Supreme Court surprises the industry by taking the case, and ultimately reverses the lower court, the result could have huge impacts beyond the net neutrality issue.
At a minimum, a decision rejecting common carrier regulation of broadband would prevent Democrats from re-imposing such heavy-handed regulation when Democrats -- inevitably -- regain control of the White House and take back the FCC. In turn, greater assurances of long-term regulatory stability could drive more substantial network investment.
We think the odds of taking the case are one-in-three. The upcoming FCC order repealing common carrier broadband regulation itself is subject to appeal. So the issuance of the FCC order does not make the regulatory change a totally done deal. In addition, the Court could be attracted to one of the big overarching concerns raised in these appeals. When is a matter simply too big for an agency to handle without clear guidance from Congress?
Congress never explicitly authorized regulating broadband as a public utility. Nonetheless, can the FCC infer it has the power to impose such a sweeping regulatory regime -- created for telephone service in the 1930s -- on the broadband services of today?
Some conservatives hope the net neutrality case will become a precedent for curtailing the federal bureaucracy, limiting the quasi-legislative power of agency officials. The newest Supreme Court member, Justice Neil Gorsuch, has questioned the deference federal courts accord government agencies (the Chevron Doctrine), raising the hopes of some conservatives that he could become a force for more limited government.
The Court could decide in December or January whether to take the case. A certiorari grant (taking the case) in itself would be a big catalyst event favoring cable operators and telcos. If it proceeds, oral arguments would likely be held in April and a decision issued around the middle of next year.
* United States Telecom Association v. FCC, U.S. Supreme Court. Appeal from the U.S. Court of Appeals for the DC Circuit.
Paul Glenchur analyzes appellate litigation with significant potential impact. In the Supreme Court, for example, he analyzed and accurately predicted outcomes affecting copyright liability for internet retransmission of broadcast television signals (American Broadcasting Co. v. Aereo), the scope of damages liability for design patent infringement (Samsung Electronics v. Apple, Inc.), and the availability of tax subsidies for health insurance purchased on federally-administered Obamacare exchanges (King v. Burwell). He has also analyzed major cases at the federal appellate court level, particularly in telecom and media disputes. He is a former judicial law clerk in the U.S. Court of Appeals for the Ninth Circuit, regulatory attorney at the FCC, litigator in private practice and is a member of the California and DC Bars, the Supreme Court Bar and the Federal Communications Bar Association. He is also a member of the ABA Section on Antitrust Law.
