7
A STRONG DETERRENT EFFECT
| Hard-core cartels are highly damaging to consumers and to the economy in general. The Government believes that the current level of fines does not deter involvement in cartels. |
| There is a strong case for introducing criminal sanctions against individuals who engage in hard-core cartels. |
| The new criminal offence would need to catch price-fixing, market-sharing and bid-rigging cartels. It should target individuals who set up and maintain cartels, and also senior executives or directors who either condone or encourage the arrangement. |
| There would be real advantages for the main prosecuting authority to be the OFT. It will be able to bring a criminal case against an individual even where the case against the firm is being pursued by the European Commission. |
7.1 Competition law works best where it acts as a real deterrent against individuals and companies engaging in anti-competitive behaviour.
7.2 In most cases, the Competition Act 1998 provides a sound basis for deterrence. But for the most damaging form of anti-competitive behaviour engaging in a "hard-core" cartel the Government believes that there is a strong case for strengthening the penalties, with the introduction of criminal sanctions against individuals. A new criminal regime would work alongside the existing civil regime.
THE CASE AGAINST HARD-CORE CARTELS
What is a
hard-core
cartel?
7.3 Hard-core cartels involve firms making a network of agreements, often in secret, which are deliberately designed to ensure that unsuspecting enterprises and individuals get a raw deal. They are highly damaging to their customers and to the economy in general.
7.4 The OECD defines the essence of a "hard-core" cartel as being:
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"an anti-competitive agreement, anti-competitive concerted practice or anti-competitive arrangement by competitors to fix prices, make rigged bids (collusive tenders), establish output restrictions or quotas, or share or divide markets by allocating customers, suppliers, territories, or lines of commerce"1
7.5 Hard-core cartels either raise or maintain prices at higher levels than they would be if competition were not distorted. They can restrict the supply of goods and services to consumers and businesses or make them unnecessarily expensive. The money that leaves consumers' pockets simply becomes extra profit for the firms involved.
7.6 The US competition authorities estimate that cartels, on average, lead to a 10% increase in the price of the goods or services affected. By adversely affecting the efficient running of the economy, the potential harm to society could be much greater a cartel can affect up to 20% of the volume of commerce.
| Box 7.1: The OECD's work on hard-core cartels |
| The Competition Law and Policy Committee of the OECD has reported that in the US alone, ten recently condemned international hard-core cartels: |
| Cost individuals and business many hundreds of millions of dollars annually. |
| Affected over $10 billion in US commerce, with overcharges of over $1 billion. |
| Caused even more harmful economic waste estimated at over $1 billion. |
| The OECD recognised that, to calculate the global harm of all cartels, these striking numbers would have to be increased by: |
| The harm these cartels had done outside the US. |
| The harm done by other successfully challenged international and domestic cartels. |
| The much larger number of undiscovered and unproven hard-core cartels. |
| They concluded that although no such calculation was possible, cartels are clearly a major and largely invisible drain on the world's economy.
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7.7 The OECD estimates that the drain to the US economy from recently exposed cartels runs into billions of dollars. But academics2 estimate that the US authorities, even with their stronger investigation powers, only manage to detect around a sixth of cartel activity.
7.8 In the past year, the OFT has launched investigations into eight possible cartels in such diverse markets as services to domestic consumers and services to local authorities, milk, construction materials and fabricated metal. These show that cartels may be operating in the UK at the local level in major cities as well as across the whole economy.
Other countries
7.9 Some countries take a tougher line on hard-core cartels than the UK has done so far. In the US, for example, criminal penalties have been on the statute book for antitrust offences since 1890, and these penalties have been applied actively. During the 1990's, the US Department of Justice successfully prosecuted thirty five people a year on average. This has helped to raise the profile of competition law within the business community. The US authorities believe that, as a result, business executives understand the harm that cartels can cause, and the risks associated in engaging in them. The importance of strong competition between firms is therefore much more ingrained in the US than in the UK.
7.10 The US authorities are also able to take action against cartels which have worldwide effects. In the recent Vitamins cartel case (see Box 7.2), the US authorities imposed fines of $500 million and $225 million respectively against a Swiss and a German firm. They also obtained criminal convictions against six European executives for engaging in price-fixing. These executives have subsequently agreed to serve their sentences in US jails.
7.11 Other countries also have criminal sanctions against individuals involved in hard-core cartels. Canada has long criminalised serious competition breaches. Japan also has criminal sanctions and Australia is considering introducing them.
7.12 Within Europe, Austria, France, Norway and Ireland all have a criminal offence covering cartels and in Germany bid-rigging is a criminal offence. Sweden is currently considering introducing a criminal offence for cartels.
| Box 7.2: Some recent cartel cases |
| Global Lysine Cartel
Between 1993 and 1996, the world's five leading producers of Lysine, an animal feed additive, colluded to fix both prices and sales quotas. As a result of this, the world price of Lysine doubled on sales of over $1.4 billion. The cartel was discovered and cartel members prosecuted. Fines of more than $100 million in the US and Canada and more than 105 million euros in the EU were levied.
The Global Vitamins Cartel
Cartel members operated a highly sophisticated and complex operation to fix prices and share markets for certain types of vitamins. This cartel was hidden for a decade and the OECD has estimated that it produced $500 million of overcharges in the US alone. Cartel members were successfully prosecuted and fines of over $1 billion were levied. Three Swiss executives from one firm and three German executives from another have agreed to serve time in US prisons.
The French TGV Cartel
French competition authorities successfully took action against a domestic cartel amongst building firms bidding for work on France's high speed train system. The cartel was destabilised by a foreign firm who planned to enter the bidding. The cartel offered the new entrant FF75 million to submit a higher bid on one part of the project and not to bid at all for other parts of the work. The competitor firm rejected the payment and after another attempt by cartel members to disrupt the bidding, the cartel was discovered. Cartel members were collectively fined FF378 million.
The UK Volvo Cartel
Volvo dealers agreed not to allow any discounts on new cars bought by retail customers and to limit discounts to commercial customers to 2.5%. This cartel, which operated for varying periods during the late 1990's, was uncovered by the OFT just before the Competition Act 1998 came into force. The OFT estimate that in the time the cartel was operating consumers may have paid £250 more than they should have for a vehicle. |
DETERRING INDIVIDUALS - CRIMINAL SANCTIONS
7.13 For most forms of anti-competitive behaviour, large fines against companies act as an effective deterrent. But for cartels there is good evidence that the current level of fines is not enough (see Box 7.3).
7.14 One option would be to increase the maximum level of fines significantly perhaps six to ten times the existing maximum fines. The Government does not believe that fines at this level would be proportionate.
7.15 A US study3 indicates that more than half of firms convicted of price-fixing would go into liquidation if required to pay the optimal fine. This would not be fair. In many cases, the cartel will only have covered one aspect of the firm's business and the real participants will have been the few executives involved. Very large fines would damage innocent employees, shareholders and creditors who have done nothing to harm consumers or break the law.
| Box 7.3: Why don't fines provide an effective deterrent against cartels? |
| If fines are to deter firms and their executives effectively, they need to be set at a level which is greater than the expected gains from participating in a cartel. |
| US evidence shows that cartels often raise prices by around 10%. Increasing prices will have some dampening effect on demand so a cartelist might increase its profits by a smaller proportion. Conservatively, they might do so by around 5%. If the cartel operates for six years (as the average US cartel is thought to do), then the total benefit might be 30% of annual turnover. |
| The Competition Act 1998 allows fines to be imposed at this level up to 10% of annual turnover in the relevant market for a maximum of three years. But not all cartels will be caught: in the US, estimates suggest that only a sixth of cartels are detected. |
| The expected fine for the would-be cartelist is the probability of being caught multiplied by the likely fine (ie a sixth of 30%), around 5% of annual turnover. |
| Faced with very high likely benefits arising from engaging in a cartel, the expected fine is unlikely to act as a meaningful deterrent. |
7.16 Therefore, the Government believes that for cartels, the level of fines against firms should remain at the same level as at present but that there should be specific sanctions against individuals engaging in the cartel. The threat of a criminal conviction and the possibility of a prison sentence means that individuals are more likely to think very carefully before engaging in cartels. Or, if they are directed to do so by their managers, they may be far more willing to inform the authorities.
7.17 Some countries impose criminal fines against individuals involved in serious competition breaches. The Government believes that this would improve the deterrent effect of our regime, but is unlikely to provide adequate protection against cartels. In practice firms could find ways to cover the costs for individuals fined. The New Zealand Government is currently seeking to outlaw exactly this behaviour.
7.18 The Government's recent peer review of competition policy asked competition experts for their views on the increased deterrence of criminal penalties. In the UK, 83% of those questioned believed that the introduction of criminal penalties against individuals who engage in cartels would improve our regime.
THE CRIMINAL OFFENCE
Catching the right agreements
7.19 The new criminal offence will cover hard-core cartels only widely recognised as the most serious form of competition breach. The most common form of hard-core cartel involves illegal price-fixing where a number of firms agree what price should be charged for a particular product. In most cases, this will be above what the competitive market price would be.
7.20 However, cartels can also involve conduct which achieves the same economic result by different means. This includes agreeing not to compete for each other's customers which leaves each firm free to set higher prices (market sharing). Or firms could agree to reduce levels of output which also increases the price that they can charge.
7.21 In some cases, firms will agree to inflate the price charged in a tender-bidding process and enter bids which ensure that one company in the cartel will win, but on better terms than would otherwise be the case (collusive tendering). The OFT believes that public sector contracts are particularly vulnerable to these practices. As such, they could hit taxpayers hard because Local Authorities or Government departments have to pay more for public services.
7.22 In all these cases, the effect is the same prices rise and consumers pay more than they should. The Government intends that the new criminal offence will cover each of these different types of cartel. Defining the offence in a way that distinguishes legitimate agreements from illegitimate ones is likely to be more difficult in some areas, in particular market sharing. The Government is keen to avoid encouraging disguised price-fixing through such arrangements.
7.23 The Government is also considering whether the offence should only catch involvement in horizontal agreements between competitors or whether certain types of vertical agreement, especially those which are already outside the existing EC exemptions and involve abuse of market power, should also be caught. The Government invites views on whether to adopt a broader offence which will catch involvement in illegal vertical agreements or to confine the offence to horizontal agreements between competitors.
The interplay with European law
7.24 European competition law is directly applicable in the UK where cartels affect inter-state trade. As many of the most serious cartels are international, the interplay of EC and UK regimes is important. The EC regime, like the UK's Competition Act, operates against undertakings not individuals. There is no provision in European law for individual criminal penalties. However, a new criminal offence in UK domestic law would apply to individuals involved in illegal agreements irrespective of whether action against the undertaking was taken under existing EC or UK law. The Government is therefore concerned to ensure that introducing a new criminal offence does not cause significant divergence from European law.
7.25 Competition law distinguishes between agreements which are anti-competitive and those which have strong offsetting or countervailing benefits. Companies often make commercial agreements to work together to bring a product to market. This can mean that they share technology or resources and become more efficient through doing so. Such joint working arrangements can improve the supply of goods and services and benefit business customers and consumers. An example is the ticketing arrangements between London Underground and bus and rail operators in and around London. These agreements make it easy for customers to travel freely between one transport operator and another. They demonstrate that a network of agreements can have a positive effect.
7.26 Under both EC and UK law it is possible to exempt a restrictive agreement with significant countervailing benefits. In some cases, this can be done retrospectively. Block exemptions can also be issued for certain categories of agreements. The type of secret agreements which bind hard-core cartels together are highly unlikely to be capable of exemption under EC law. However, the Government recognises the need to define carefully the criminal offence so as to make it clear that only individuals actively involved in agreements which could never be exempt would be caught. The Government has no desire to criminalise involvement in benign agreements which would not be unlawful under existing competition law.
Catching the right people
7.27 Most importantly, the offence must catch the right people. The Government wishes to ensure that the law targets those who set up and maintain the cartel, as well as any senior executives or directors who know about the arrangement and condone or encourage it.
7.28 We have identified two broad approaches to the offence itself, both of which involve setting out on the face of the statute the types of hard-core cartel activities identified above: price-fixing, market sharing and bid-rigging.
7.29 The first would make it unlawful for a person to participate in an agreement whose purpose is one or more of the hard-core cartel activities identified above, where the agreement also involves a breach of either Article 81 of the EC Treaty or the equivalent prohibition of the Competition Act 1998 (Chapter I).
7.30 This approach maintains a direct link with a breach of Article 81 or Chapter I. However, where there has not been a prior determination of an infringement of those provisions, a court would first have to find that the agreement breached one of them. This could require a lay jury with no competition expertise to consider potentially complex economic arguments.
7.31 The second approach is to remove the direct link to a finding that an undertaking has breached Article 81 or Chapter I. Instead the offence would be defined as the dishonest participation in an agreement which has, as a purpose, one or more of the specified hard- core cartel activities. A jury would need to determine whether a defendant had acted dishonestly. A defendant could use as his defence the claim that he honestly believed he was acting in accordance with Article 81 or Chapter I.
7.32 This approach avoids the real difficulties involved in requiring a prior determination regarding a breach of either Article 81 or Chapter I by a jury. It would also remove the possibility of a defendant's employer frustrating court proceedings by notifying an agreement to the European Commission, although this option would, in any case, only be available until EC modernisation. The disadvantage of the approach is that the direct link with a breach of these provisions is lost.
7.33 To be effective, it is critical that the offence is defined in a way which is both clear and easy for business and the courts to understand. It must also be actively applied so that its deterrent effect is genuinely felt. The Government recognises that defining the offence is a complex task and would welcome views on the proposals outlined above and other possible approaches.
Penalties
7.34 To gauge the level of penalty that should be applied, it is important to consider offences which have similar characteristics. Offences such as insider dealing and obtaining property by deception carry the possibility of a custodial sentence of between 7 and 10 years. In the international arena, Canada and Japan can have penalties of 5 years imprisonment for engaging in cartels and in the US, the maximum available sentence is 3 years.
7.35 Hard-core cartels are serious conspiracies which defraud business customers and consumers and have wide economic impacts. If discovered they jeopardise the interests of shareholders, creditors and employees. Their costs to the global economy runs into billions of dollars. The offence merits a strong sentence. The Government believes that the offence should be triable in both the higher and lower courts ('triable either way') and seeks views on what level of sentence should be applied.
7.36 The Government is concerned to avoid the possibility of individual fines being paid by employers (who are the main beneficiaries of the cartel) and for this reason does not propose fines an alternative sanction to a custodial sentence. Insider dealing and obtaining property by deception do carry the possibility of a fine as an alternative sanction, but the risk of an employer paying a fine is minimal as they are rarely the beneficiaries of the behaviour.
THE PROCEDURES
Investigation and prosecution
7.37 The introduction of criminal sanctions has significant implications in the way cases are investigated and prosecuted. Procedural safeguards are required to ensure a fair trial. To secure a successful criminal conviction, guilt must be proved "beyond reasonable doubt" rather than "on the balance of probabilities", the required civil standard of proof. Only in the most serious cases are criminal charges likely to be brought against individuals. The majority of cases will continue to be taken forward under the existing civil regime. It will be important both that OFT meets the new higher safeguards for criminal cases and that it retains its effectiveness in dealing with the full range of competition breaches.
7.38 The Government believes there are good reasons for the OFT to be the main prosecuting authority for the offence4. The OFT has primary responsibility in the UK for uncovering cartels and has developed the necessary expertise. However, the OFT has no responsibility at present for bringing prosecutions, so would need to develop the capability to do so.
7.39 The Government proposes to ensure that the OFT has sufficiently strong powers of investigation including powers to carry out surveillance and use covert human intelligence sources. In cases where surveillance is used, the OFT could seek the assistance of the police during investigations. The Government considers that strong powers of investigation are an essential component in successfully detecting and prosecuting the offence. Without such powers it would be difficult to detect the most damaging cartels. For example, in the Lysine case, the US authorities planted hidden cameras with the co-operation of one of the cartel members. The cartel members were caught on camera in hotel rooms concluding their deals which provided valuable evidence in securing convictions.
7.40 In all cases, it will be essential that procedural safeguards are followed to ensure that defendants receive a fair trial. The OFT will need to caution those who are under suspicion to ensure that they are fully aware of their right to silence, and manage documents carefully to protect the evidence trail. If the OFT are the main prosecuting authority, different divisions in the OFT would handle the investigation and prosecution phases of a case. The formal decision to prosecute would be made by a functionally separate part of the OFT with advice from the OFT's legal branch. The legal branch may also need to operate as a separate entity. This model is used by other bodies who exercise powers of investigation and prosecution such as the Inland Revenue and the Serious Fraud Office.
7.41 In deciding whether to issue proceedings, the OFT would also need to follow the code for crown prosecutors satisfying itself that that there was a realistic prospect of conviction and that prosecution was in the public interest.
7.42 The Government does not see a strong case for the sectoral regulators to have powers to prosecute. Rather it would be more efficient for them to refer cases to the OFT, who will have the necessary investigatory powers and evidence handling procedures in place.
The interplay with European law
7.43 The European Commission's modernisation proposals would decentralise powers to enforce Article 81. In most cases where cartels are suspected in the UK, the OFT will investigate. Under modernisation, the imposition of penalties would be a matter for Member States' law rather than Community law. The OFT would therefore be able to act against those agreements it believes breach Article 81. This should help to simplify court proceedings.
7.44 Some mainly global cartels will be investigated by the European Commission. In such cases, the Government intends that the new criminal offence will allow the UK authorities to take action separately against individuals involved in the cartel. The agreement will be caught by the new offence where it was implemented or intended to be implemented in the UK.
7.45 EC procedures are conducted under civil standards of evidence. So where the OFT wished to bring a case against individuals involved in the cartel, it would need to ensure that evidence was gathered to criminal standards. Where evidence had been used in a prior case by the Commission, the OFT investigators might have to secure fresh evidence for a criminal trial to proceed. The Government proposes, however, that a prior finding in EC proceedings should be admissible as evidence in a subsequent criminal trial.
Link between civil and
criminal cases
7.46 Where the OFT took action against an undertaking under either EC or domestic civil law and separately against an individual under criminal law, it would need to ensure that the interaction of investigations and proceedings in each case does not prejudice the other.
7.47 The Government invites views on whether the new criminal offence should extend to corporate bodies. There are procedural efficiencies to be gained by enabling the OFT to bring a case against a company and its officers rather than to have to institute two separate sets of proceedings under different law. Corporate bodies are also the primary beneficiaries of the revenues raised by a cartel. Under general principles of criminal law, culpability on the part of those in key corporate positions would also incur corporate liability. Set against this is the divergence with EC law which would occur in the small number of cases in which the OFT took criminal proceedings as well as the difficulty of requiring a lay jury to hear a potentially complex economic case against a company.
Encouraging whistle-blowers
7.48 The Government believes that encouraging whistle-blowing is a critical success factor in securing convictions under the new criminal offence.
7.49 There is a risk that introducing a criminal offence could act as a disincentive to those considering whistle-blowing because employees might fear incriminating themselves in a criminal investigation. In the US, many of the largest cartel cases have come to light and been successfully prosecuted on the basis of information gained from whistle-blowers. However, the key to this is the competition authorities' ability to selectively plea bargain on behalf of executives who co-operate with their investigations. Those who come forward can do so in the legitimate expectation that they could be offered some degree of leniency.
7.50 The UK does not have a formal mechanism akin to plea bargaining. However, under the code for crown prosecutors, cases against individuals must be brought in the public interest and the OFT could exercise its prosecutorial discretion and decide not to bring a case against an individual who had provided valuable evidence central to the successful prosecution of key members of a cartel. The OFT would need to decide each case on its own merits, but whistle-blowers could come forward in the knowledge that they may not face a criminal trial5.
7.51 The Government proposes that prosecutions under the new offence can only be made by the OFT, or with the OFT's consent. This would prevent OFT's prosecutorial discretion from being undermined by subsequent private actions against whistle-blowers.
1 OECD: Hard Core Cartels: Meeting of the OECD Council at Ministerial Level, 2000.
2 PG Bryant and EW Eckhard, "Price Fixing: The Probability of Getting Caught", 1991 Review of Economics and Statistics 531
3 Craycraft, C, Craycraft, JL and Gallo JC, "Antitrust Sanctions and a Firm's Ability to Pay" (1997)
4 OFT's prosecution authority would extend to England and Wales only. In Scotland, the Lord Advocate is responsible for the prosecution of crime. This function is exercised at local level by Procurators Fiscal as his representatives. In Northern Ireland, prosecution would fall to the Director of Public Prosecutions.
5 In Scotland and Northern Ireland this would be a matter for respectively the Lord Advocate/Procurators Fiscal and the Director of Public Prosecutions. The OFT could provide its view on the appropriate course of action.
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