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From Antitrust Law Daily, September 30, 2015

Injunction requiring NCAA to allow schools to pay student-athletes $5,000 in deferred compensation vacated

By Peter Reap, J.D., LL.M.

The federal district court in Oakland’s judgment and permanent injunction that, among other things, required the National Collegiate Athletic Association (“NCAA”) to allow its member schools to pay student-athletes up to $5,000 per year in deferred compensation was vacated in that respect by the U.S. Court of Appeals in San Francisco because the district court erred in concluding that small payments in deferred compensation was a substantially less restrictive alternative restraint under the rule of reason to the NCAA’s current rules (O’Bannon v. National Collegiate Athletic Association, September 30, 2015, Bybee, J.). In all other respects, the decision of the district court was affirmed, including: (1) the court was not precluded from reaching the merits of the student-athletes’ Sherman Act claim; (2) the NCAA’s rules were not exempt from antitrust scrutiny and must be analyzed under the rule of reason; and (3) allowing NCAA member schools to give scholarships up to the full cost of attendance was a proper less restrictive alternative to the current NCAA rules.

Background

A group of current and former student-athletes who played on men’s football or basketball teams at Division I member schools and conferences filed suit against the National Collegiate Athletic Association (NCAA), alleging that the NCAA violated federal antitrust law by conspiring with Electronic Arts Inc., and Collegiate Licensing Company to restrain competition for the commercial use of their names, images, and likenesses (“NIL”) in television broadcasts and NCAA brand video games. In particular, the plaintiffs challenged NCAA rules that bar student-athletes from receiving a share of the revenue the NCAA and member schools earn from the sale of those licenses.

In April 2014, the federal district court in Oakland granted the plaintiffs’ motion for summary judgment on their antitrust claims against the NCAA and set their damages claims for a bench trial. In August 2014, the district court enjoined (with an effective date of August 1, 2015) the NCAA from enforcing its prohibition on student-athlete compensation. Specifically, the district court enjoined the NCAA from prohibiting its member schools from giving student-athletes scholarships up to the full cost of attendance at their respective schools and up to $5,000 per year in deferred compensation, to be held in trust for student-athletes until after they leave college.

The NCAA appealed. The appellate court granted a stay of the district court’s injunction on July 31, 2015, to preserve the status quo.

The Ninth Circuit Could Reach the Merits of the Antitrust Claims

On appeal, the NCAA contended that the plaintiffs’ Sherman Act claim failed on the merits, but it also argued that the court was precluded altogether from reaching the merits, for three independent reasons: (1) the U.S. Supreme Court held in NCAA v. Board of Regents of the University of Oklahoma, 468 U.S. 85 (1984), that the NCAA’s amateurism rules were “valid as a matter of law”; (2) the compensation rules at issue were not covered by the Sherman Act at all because they did not regulate commercial activity; and (3) the plaintiffs had no standing to sue under the Sherman Act because they have not suffered “antitrust injury.” None of these arguments were persuasive, the Ninth Circuit held.

The Board of Regents case. The Board of Regents Court discussed the NCAA’s amateurism rules at great length, but did not do so in order to pass upon the rules’ merits, given that they were not before the Court, the Ninth Circuit determined. Rather, the Court discussed the amateurism rules for a different and particular purpose: to explain why NCAA rules should be analyzed under the rule of reason, rather than held to be illegal per se.

Board of Regents, in other words, did not approve the NCAA’s amateurism rules as categorically consistent with the Sherman Act. Rather, it held that, because many NCAA rules (among them, the amateurism rules) were part of the “character and quality of the [NCAA’s] ‘product, no NCAA rule should be invalidated without a rule of reason analysis. The Court’s lengthy praise of amateurism, though impressive-sounding, was therefore dicta.

Even if the language in Board of Regents addressing amateurism was not dicta, it would not support the tremendous weight that the NCAA sought to place upon it, according to the appellate court. The Court’s opinion supports the proposition that the preservation of amateurism was a legitimate procompetitive purpose for the NCAA to pursue, but the NCAA was not asking the court to find merely that its amateurism rules were procompetitive. Instead, it asked the court to hold that those rules were essentially exempt from antitrust scrutiny. Nothing in Board of Regents supported such an exemption.

The compensation rules regulate commercial activity. The NCAA next argued that the court could not reach the merits of the plaintiffs’ Sherman Act claim because the compensation rules were not subject to the Sherman Act at all. The NCAA pointed out that Section 1 of the Sherman Act applies only to “restraint[s] of trade or commerce,” 15 U.S.C. § 1, and claims that its compensation rules were mere “eligibility rules” that do not regulate any “commercial activity.”

This argument was not credible and was rejected by the Ninth Circuit. Although restraints that have no effect on commerce are indeed exempt from Section 1, the modern legal understanding of “commerce” is broad, “including almost every activity from which the actor anticipates economic gain.” Phillip Areeda & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application, ¶260b (4th ed. 2013). That definition surely encompasses the transaction in which an athletic recruit exchanges his labor and NIL rights for a scholarship at a Division I school because it is undeniable that both parties to that exchange anticipate economic gain from it, the court said. Thus, the NCAA’s compensation rules are within the ambit of the Sherman Act.

The plaintiffs demonstrated injury in fact. The NCAA’s last argument antecedent to the merits was that the plaintiffs’ Section 1 claim failed at the threshold because the plaintiffs failed to show that they have suffered “antitrust injury.” The plaintiffs showed that they were injured in fact as a result of the NCAA’s rules having foreclosed the market for their NILs in video games, the court determined. Because the plaintiffs showed that, absent the NCAA’s compensation rules, video game makers would likely pay them for the right to use their NILs in college sports video games, the plaintiffs satisfied the requirement of injury in fact and, by extension, the requirement of antitrust injury.

Merits of the Antitrust Claim

The appropriate rule to review the plaintiffs’ Section 1 antitrust claim was the rule of reason, according to the Ninth Circuit. As the Supreme Court observed, the NCAA “market[s] a particular brand . . . [that] makes it more popular than professional sports to which it might otherwise be comparable.” Board of Regents, 468 U.S. at 101–02. Because the “integrity of the ‘product’ cannot be preserved except by mutual agreement,” “restraints on competition are essential if the product is to be available at all.”

There is a three-step framework for the rule of reason: “[1] The plaintiff bears the initial burden of showing that the restraint produces significant anticompetitive effects within a relevant market. [2] If the plaintiff meets this burden, the defendant must come forward with evidence of the restraint’s procompetitive effects. [3] The plaintiff must then show that any legitimate objectives can be achieved in a substantially less restrictive manner.” Tanaka v. Univ. of S. Cal., 252 F.3d 1059, 1063 (9th Cir. 2001).

Significant anticompetitive effects. First, the NCAA argued that because the plaintiffs never showed that the rules reduce output in the college education market, the plaintiffs did not meet their burden of showing a significant anticompetitive effect. Second, it argued that the rules have no anticompetitive effect because schools would not pay student-athletes anything for their NIL rights in any event, given that those rights are worth nothing. And finally, the NCAA argued that even if the district court was right that schools would pay student-athletes for their NIL rights, any such payments would be small, which means that the compensation rules’ anticompetitive effects were not significant.

The first two arguments could be disposed of quickly, the appellate court noted. First, the NCAA’s contention that the plaintiffs’ claim failed because they did not show a decrease in output in the college education market was simply incorrect. Although output reductions are one common kind of anticompetitive effect in antitrust cases, a reduction in output is not the only measure of anticompetitive effect.

At trial, the plaintiffs demonstrated that the NCAA’s compensation rules had an anticompetitive effect: they fix the price of one component of the exchange between school and recruit, thereby precluding competition among schools with respect to that component. The district court found that although consumers of NCAA football and basketball may not be harmed directly by this price-fixing, the “student-athletes themselves are harmed by the price-fixing agreement among FBS football and Division I basketball schools.” The athletes accept grants-in-aid, and no more, in exchange for their athletic performance, because the NCAA schools agreed to value the athletes’ NILs at zero, “an anticompetitive effect.” This anticompetitive effect satisfied the plaintiffs’ initial burden under the rule of reason.

Second, the NCAA’s argument that student-athletes’ NILs are, in fact, worth nothing was simply a repackaged version of its arguments about injury in fact, which the Ninth Circuit had rejected.

Finally, the NCAA’s contention that any NIL compensation student-athletes could receive in the absence of its compensation rules would be de minimis and that the rules therefore do not significantly affect competition in the college education market was rejected. Because the compensation rules have a significant anticompetitive effect on the college education market, the court proceeded to consider the procompetitive justifications the NCAA proffered for those rules.

Procompetitive effects. The NCAA offered the district court four procompetitive justifications for the compensation rules: (1) promoting amateurism, (2) promoting competitive balance among NCAA schools, (3) integrating student-athletes with their schools’ academic community, and (4) increasing output in the college education market. The district court accepted the first and third and rejected the other two.

Although the NCAA’s briefs stated that the district court erred in failing to “credit all four justifications fully,” the NCAA focused its arguments on appeal entirely on the first proffered justification—the promotion of amateurism. The appellate court therefore accepted the district court’s factual findings that the compensation rules do not promote competitive balance, that they do not increase output in the college education market, and that they play a limited role in integrating student-athletes with their schools’ academic communities, since the court was offered no meaningful argument that those findings were clearly erroneous.

The district court found, and the record supported that there is a concrete procompetitive effect in the NCAA’s commitment to amateurism: namely, that the amateur nature of collegiate sports increases their appeal to consumers, the court held. Therefore, the NCAA’s compensation rules serve the two procompetitive purposes identified by the district court: integrating academics with athletics, and “preserving the popularity of the NCAA’s product by promoting its current understanding of amateurism.”

Substantially less restrictive alternatives. The third step in the rule of reason analysis is whether there are substantially less restrictive alternatives to the NCAA’s current rules. The district court identified two substantially less restrictive alternatives: (1) allowing NCAA member schools to give student-athletes grants-in-aid that cover the full cost of attendance; and (2) allowing member schools to pay student-athletes small amounts of deferred cash compensation for use of their NILs.

The district court did not clearly err in finding that allowing NCAA member schools to award grants-in-aid up to their full cost of attendance would be a substantially less restrictive alternative to the current compensation rules, the Ninth Circuit ruled. All of the evidence before the district court indicated that raising the grant-in-aid cap to the cost of attendance would have virtually no impact on amateurism. Nothing in the record, moreover, suggested that consumers of college sports would become less interested in those sports if athletes’ scholarships covered their full cost of attendance, or that an increase in the grant-in-aid cap would impede the integration of student-athletes into their academic communities.

A compensation cap set at student-athletes’ full cost of attendance is a substantially less restrictive alternative means of accomplishing the NCAA’s legitimate procompetitive purposes. There was no evidence that this cap would significantly increase costs; indeed, the NCAA already permits schools to fund student-athletes’ full cost of attendance. The district court’s determination that the existing compensation rules violate Section 1 of the Sherman Act was correct and its injunction requiring the NCAA to permit schools to provide compensation up to the full cost of attendance was proper, the appellate court explained.

However, the district court clearly erred in finding it a viable alternative to allow students to receive NIL cash payments untethered to their education expenses. The question was whether the alternative of allowing students to be paid NIL compensation unrelated to their education expenses, is virtually as effective in preserving amateurism as not allowing compensation, according to the court.

The Ninth Circuit could not agree that a rule permitting schools to pay students pure cash compensation and a rule forbidding them from paying NIL compensation were both equally effective in promoting amateurism and preserving consumer demand. The NCAA’s amateurism rule had procompetitive benefits. But in finding that paying students cash compensation would promote amateurism as effectively as not paying them, the district court ignored that not paying student-athletes was precisely what makes them amateurs.

Aside from the self-evident fact that paying students for their NIL rights would vitiate their amateur status as collegiate athletes, the court relied on threadbare evidence in finding that small payments of cash compensation would preserve amateurism as well the NCAA’s rule forbidding such payments. Most of the evidence elicited merely indicated that paying students large compensation payments would harm consumer demand more than smaller payments would—not that small cash payments will preserve amateurism. Thus, the evidence was addressed to the wrong question, the court observed.

The difference between offering student-athletes education-related compensation and offering them cash sums untethered to educational expenses was not minor; it was a quantum leap, the Ninth Circuit reasoned. In light of that, the meager evidence in the record, and the Supreme Court’s admonition that the NCAA must have “ample latitude” to superintend college athletics, Bd. of Regents, 468 U.S. at 120, it was clear the district court erred in concluding that small payments in deferred compensation are a substantially less restrictive alternative restraint. Thus, the district court’s judgment and permanent injunction were vacated insofar as they require the NCAA to allow its member schools to pay student-athletes up to $5,000 per year in deferred compensation. The district court ruling was otherwise affirmed.

Practitioner Commentary

Joel G. Chefitz, a partner in the law firm of McDermott Will & Emery, and a highly experienced sports and antitrust lawyer, offered the following expert commentary on today’s decision:

The majority opinion seems internally inconsistent. On the one hand, the opinion repeatedly acknowledges that amateurism is itself a legitimate procompetitive end for the NCAA to pursue and “that not paying student-athletes is precisely what makes them amateurs.” But then the court ignores its own repeated admission by stating that amateurism rules need to serve a procompetitive goal other than amateurism.

The test in cases like this is whether the restraint is reasonably necessary to serve a procompetitive goal. This is a fit test between the means and the end. What the Ninth Circuit seems to overlook is that the fit can’t get any better when amateurism is both the means and the end.

The court was right to reject the straw man argument that the NCAA’s rules were immune from antitrust scrutiny, but the Ninth Circuit then applied the rule of reason incorrectly to an ancillary restraint serving one of the joint venture’s core objectives. In any event, by reversing the district court’s remedy, the Ninth Circuit panel has ensured that the practical effect of the case will be limited.

The cases are Nos. 14-16601 and 14-17068.

Attorneys: Seth P. Waxman (Wilmer Cutler Pickering Hale and Dorr LLP) for National Collegiate Athletic Association. Michael D. Hausfeld (Hausfeld LL) for Edward C. O’Bannon, Jr.

Companies: National Collegiate Athletic Association; Electronic Arts Inc.; Collegiate Licensing Company

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