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Justices debate watch prices, medical students

By Bill Mears, CNN Supreme Court Producer
  • The Supreme Court hears a case involving watch maker Swatch, and retailer Costco
  • The copyright issue concerns the resale of foreign-made items in the United States
  • In another case focused on whether student doctors should pay Social Security taxes

Washington (CNN) -- Two business giants -- one a upscale manufacturer, the other a discount retailer -- clashed at the Supreme Court Monday in an important business case dealing with imported goods sold at low cost in the United States.

At issue is whether a copyright holder can block the re-sale of a foreign-made item, after it is later brought to the United States and sold for up to a third less than it might cost elsewhere. The items here are Swatch Group's Omega-brand luxury watches, and the seller is Costco, a membership warehouse popular for bulk goods and electronics.

The justices appeared split over interpreting federal copyright laws to include the multi-billion dollar "gray market" of foreign-made goods obtained through second-hand sources. Some on the bench were also openly concerned about a ruling giving U.S. copyright holders a reason to make and then control their products outside American borders.

"What earthly sense would it make to prefer goods that are manufactured abroad over those manufactured in the United States?" asked Justice Ruth Bader Ginsburg.

The high court already has ruled in prior cases that copyright holders cannot block U.S.-made goods sent overseas from later being brought back into the United States for resale. The issue now is whether copyright laws apply to foreign-made goods imported into the American market.

The Biel, Switzerland-based Omega company alleges Costco unlawfully obtained genuine Seamaster-style watches from third parties who had imported them into the United States. The stores then sold them for $1,299, a third below the Swiss firm's suggested retail price of $1,999.

The watches were engraved with the Omega emblem trademarked in the United States. The company is part of the 25-year-old Swatch conglomerate, a combination of the words "Swiss" and "watch."

Such differences in worldwide prices are often exploited by retail firms, especially on high-end luxury items. Known as parallel sales or the "gray market," the strategy costs manufacturers tens of billions of dollars a year, according to some business-generated estimates.

In oral arguments, Roy Englert, the lawyer for the largest U.S. warehouse club, said since Omega made its "first sale" of its watches abroad, it could not object when the goods were imported, then sold at a discount price. That first-sale doctrine generally gives copyright holders the ability to profit only from the original sale.

"The purpose of the first-sale doctrine is to make sure that the copyright owner gets one and only one recompense for each copy, for each lawfully made copy," he said.

"So if he sells his rights to a foreign manufacturer and distributor, he gets paid for those," replied Justice Sonia Sotomayor. "Why shouldn't he now have any additional rights to bar that authorized copy from being imported into the United States?"

"If you say there has to be a first sale, there is no problem," Justice Stephen Breyer, expressing concern. "You block that British manufacturer from sending his books to the United States, but you don't block the person to whom he sells it. Gives meaning to everything."

Omega's attorney, Aaron Panner, insisted the rules did not apply to goods the company made overseas but never authorized be shipped into the United States.

"That's just not in the text," said Justice Antonin Scalia. "Like the other side, in order to make your theory of the text appear reasonable, you have to bring in a skyhook with a limitation that finds no basis in the text."

Scalia and other justices were concerned of what they cited as vagueness in the federal copyright law. That makes the outcome of this dispute very much in question.

Omega was supported by the Obama administration, as well as many in the publishing, artistic, and electronics industry.

Washington-state based Costco is backed by online retailers EBay, Amazon, and Google, and well as fellow retailer Target Stores.

This fight has widespread implications in the struggling worldwide economy, where discounted items have grown more attractive to savvy consumers. There is an estimated $58 billion annual market for goods that are purchased abroad, then imported and resold without the permission of the manufacturer.

The case is Costco Wholesale Corp. v. Omega, S.A. (08-1423).


In a second case argued Monday, the justices were equally split on whether the Internal Revenue Service can collect Social Security taxes on student doctors.

The Mayo Foundation of Rochester, Minnesota, had sued, saying its medical residents were not full "employees" for purposes of the federal tax code.

The dilemma comes over the dual roles these future doctors perform. They are compensated for their work in hospitals and pay income taxes. But their workplace is also a learning environment, and their services come as part of their education. The argument is not merely intellectual. The Justice Department told the justices Social Security taxes for such medical residents total nearly $700 million annually.

The IRS at one time had given a student exemption for medical residents, but changed the rules for those who work more than 40 hours weekly.

The hospital's attorney, Theodore Olson, called the current rules arbitrary.

"The person is a student. They are just doing it long and arduously and they are doing it for several years so that they can be board certified as good doctors in their specialty," he said. "You are doing the types of things that you would make you a student, and you are doing it for the purposes that would make you for a student, but if you do it a little bit too much, you are too much of a student, and therefore you are not a student."

"Well, that's because of the second meaning here. It's very surprising," said Justice Stephen Breyer, appearing to agree, suggesting the rules were ambiguously written. He added, "Now I am reading the dictionary," which brought laughter in the courtroom.

"We don't know whether that's a step forward or backward," added a smiling Justice Antonin Scalia.

But Matthew Roberts, representing the Obama administration, said the medical residents "are full-time employees, and the Treasury Department has reasonably concluded that an employee's paid work does not make him an exempt student, even if he also learns from his job. They and their employers should be helping to fund the Social Security system, and they should be earning credit towards benefits so that they and their families will have something to fall back on if they become disabled or die."

Chief Justice John Roberts -- no relation to the government attorney -- appeared unconvinced. "You seem to be focusing on how many hours they are working. But what if the school says: 'Well, look, we recognize some of this is going to school and some of this is working, so just like the IRS, we are going to have an arbitrary rule and we are going to say you are being paid for just the first two hours.'"

The chief justice suggested those medical residents would then not be subject to further federal taxes.

The case is Mayo Foundation for Medical Education and Research v. U.S. (09-837).

Justice Elena Kagan sat out both arguments Monday. She had participated in briefing the cases this spring, when she solicitor general at the Justice Department, and before she was nominated to the high court. She has recused herself in three of the six cases argued this week.