Leniency programs and antitrust penalties in Competition policy

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Competition is a natural phenomenon that exists since forever. It has been present in every culture, every field of life because the natural instinct of people leads them towards outperforming competitors. Very often, especially if money is at stake, some of the parties tend to play using dishonest tools.

In my essay I am going to examine how and from where we have arrived to the 21st century situation and how can it be regulated the best, I am going to present the most relevant competition regulatory measures in Europe and in the United States. Just to back up the theoretical knowledge I will examine a few scandalistic cases from the recent past where illegal cartels have been revealed, I will show whether the leniency programs have been proven to be effective and how the companies have managed to regain power after the penalties. At the end of my paper I am going to present a few pioneering views on modern competition policy and examine whether they can have a raison d'être.

Chapter I - The history of competition law

Competition on different markets is regulated since the Ancient Roman times; Roman law has various paragraphs on ensuring fair trade. There were several acts in history but because of the fact that early trade models differed a lot from the modern ones, I am not going to put a special emphasis on dealing with historical policies.

The legislation that we can consider as a basis of today's competition policy is the antitrust law of the United States of America. The so-called Sherman Antitrust Act (1890) was the first to outlaw cartels, trusts and all kinds of monopolies considered harmful for the consumers in the USA and at the same time it required the U.S. government to investigate companies in suspicion of violating the act. In 1914 a specification entered into force called the Clayton Antitrust Act that cleared the question of exemptions and several particular situations. [1] This Act was a civil statute (carrying no criminal penalties) that prohibited mergers or acquisitions that were likely to lessen competition. The US government challenged those mergers that careful economic analysis shows were likely to increase prices to consumers. All persons considering a merger or acquisition above a certain size now had the obligation of notifying both the Antitrust Division and the Federal Trade Commission. The act also prohibited other business practices that may harm competition under certain circumstances. [2] 

At the same time the so-called Federal Trade Commission (FTC) was created: a federal organ that acted as a regulator of every competitive market in the USA. Since then there are other federal organs as well, for example the Antitrust Division of the United States Department of Justice (DoJ). On the state level the so-called state attorney general also has the legitimacy in filing suits when having found possible violations of the antitrust law, and even private law suits can be filed as well.

In Europe the historical patterns of the formation of antitrust policies are different. First of all, there are different countries with different culture and historical backgrounds. The ones where trade has emerged early, trade legislation is more sophisticated, for example France, Italy and England. In the Middle Ages guilds were formed and rudimentary legislation was defined towards anticompetitive market behavior. The European Union as a homogeneous economic integration was formed only in modern times, and despite that there are many fields of law where we cannot see a homogeneous approach from the EU, antitrust regulatory law is one of the communized fields.

Chapter II - The theory behind: monopoly and competition in economics

The classical perspective on monopolies works according to the laissez-faire mechanism. "Antitrust is seen as unnecessary as competition is viewed as a long-term dynamic process where firms compete against each other for market dominance. In some markets a firm may successfully dominate, but it is because of superior skill or innovativeness. However, according to laissez-faire theorists, when it tries to raise prices to take advantage of its monopoly position it creates profitable opportunities for others to compete. A process of creative destruction begins which erodes the monopoly. Therefore, government should not try to break up monopoly but should allow the market to work." [3] 

On the other hand, Adam Smith mentioned the cartel problem in his much-cited opus, The Wealth of Nations:

„People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary." [4] 

Smith recognized the problem that may result from the presence of large potent cartels on the market but at that time he did not propose a concrete solution.

The neoclassical approach presents somewhat different perspectives. "A simple neo-classical model of free markets holds that production and distribution of goods and services in competitive free markets maximizes social welfare. This model assumes that new firms can freely enter markets and compete with existing firms, or to use legal language, there are no barriers to entry. […]Contrasting with the allocatively, productively and dynamically efficient market model are monopolies, oligopolies, and cartels. When only one or a few firms exist in the market, and there is no credible threat of the entry of competing firms, prices rise above the competitive level, to either a monopolistic or oligopolistic equilibrium price. Production is also decreased, further decreasing social welfare by creating a deadweight loss. Sources of this market power are said to include the existence of externalities, barriers to entry of the market, and the free rider problem. Markets may fail to be efficient for a variety of reasons, so the exception of competition law's intervention to the rule of laissez faire is justified if government failure can be avoided. Orthodox economists fully acknowledge that perfect competition is seldom observed in the real world, and so aim for what is called "workable competition". This follows the theory that if one cannot achieve the ideal, then goes for the second best option by using the law to tame market operation where it can." [5] 

The economists of the Chicago School retain that some anticompetitive behavior can actually stimulate the market and competition.

Chapter III - What is considered anticompetitive?

There is a wide range of activities that are considered to be anticompetitive behavior because the US antitrust law is really strict and the market participants have to conduct clear business from many aspects. A few typical behavioral forms are discussed in this chapter.

Figure 1: http://en.wikipedia.org/

wiki/File:Monopoly-surpluses.svgThe most common type of appearance of market manipulation is price fixing: it is a type of business agreement between competitors that produce or provide the same product or service regarding its pricing. It is good for them because eliminating competition among them ensures them higher revenues because like this they don't have to lower prices to their marginal cost of production but they can settle at a somewhat higher level, therefore causing a loss in the consumer welfare known as deadweight loss (see illustration).

Another method is bid rigging that is a form of price fixing and market allocation that involves an agreement in which one party of a group of bidders will be designated to win the bid. There are a few subtypes to bid rigging: "Subcontract bid rigging, where some of the conspirators agree not to submit bids, or to submit cover bids that are intended not to be successful, on the condition that some parts of the successful bidder's contract will be subcontracted to them. In this way, they "share the spoils" among themselves. Bid suppression occurs where some of the conspirators agree not to submit a bid so that another conspirator can successfully win the contract. Complementary bidding, also known as cover bidding or courtesy bidding, occurs where some of the bidders bid an amount knowing that it is too high or contains conditions that they know to be unacceptable to the agency calling for the bids. Bid rotation occurs where the bidders take turns being the designated successful bidder, for example, each conspirator is designated to be the successful bidder on certain contracts, with conspirators designated to win other contracts. This is a form of market allocation, where the conspirators allocate or apportion markets, products, customers or geographic territories among themselves so that each will get a "fair share" of the total business, without having to truly compete with the others for that business." [6] 

Geographic market allocation is an agreement between competitors not to compete within each other's geographic territories. [7] 

The so-called Walker Process fraud is a very delicate and hardly determinable way of fraud: it refers to "the knowing and deliberate fraud perpetrated on the patent office as opposed to mere acts of inequitable conduct. Proving that a patent applicant engaged in Walker Process fraud does not by itself prove liability for an antitrust violation. The accused infringer must still prove the individual elements of an antitrust claim. Antitrust claims based on Walker Process fraud require significant time and resources to litigate." [8] 

In 2007 a new leniency approach has been introduced: the new program considered strictly horizontal cartels as anticompetitive collusions and declared vertical cooperation legitime.

Chapter IV - Today's regulatory measures in the EU and in the US: penalties and leniency programs

It is the Treaty on the Functioning of the European Union (TFEU) that contains the regulatory measures to be followed by the competition-regulatory organs of the member-states. The two hinges of the EU competition policy are defined in Article n. 81 and n.82: 81) the prohibition of cartel formation and other restrictive business practices 82) the regulation of abuse of dominance. Articles 86 and 87 regulate the role of the state in the market. Art. 86 states clearly that nothing in the rules can be used to obstruct a member state's right to deliver public services, but that otherwise public enterprises must play by the same rules on collusion and abuse of dominance as everyone else. Article 87 - similar to Art. 81 - lays down a general rule that the state may not aid or subsidize private parties in distortion of free competition, but then grants exceptions for things like charities, natural disasters or regional development.

Since 2006 there is a new mechanism regarding the penalty measures: "In order to deter companies from ever entering into seriously illegal conduct: the Commission may add to the amount as calculated above a sum equal to 15% to 25% of the yearly relevant sales, whatever the duration of the infringement. Such an "entry fee" will be applied in cartel cases and may be applied in other types of anti-trust infringements. In other words, the mere fact that a company enters into a cartel could "cost" it at least 15 to 25% of its yearly turnover in the relevant product." Each previous infringement justifies an increase of the fine. The amount of the fines is paid into the Community Budget. [9] â€žThe fines therefore help to finance the European Union and reduce the tax burden on individuals." [10] 

The EU's case law contains the so-called 'Leniency Notice': "The purpose of leniency programs is to assist national competition authorities in their efforts to detect and terminate cartels and to punish cartel participants. The competition authorities consider that the voluntary assistance with the above objectives has an intrinsic value for the economic well-being of individual member states as well as the common market which may justify immunity in certain cases and a reduction of any fine in others." [11] "This notice sets out the framework for rewarding cooperation in the Commission investigation by undertakings which are or have been party to secret cartels affecting the Community." [12] Gaining immunity from fines has two types: type 1A and 1B. Gaining reduction from fines is called type 2 leniency. In order to gain leniency notice, a company has to fulfill three conditions. Whether or not the company is competent in the three conditions, it is announced at the end of the process. The first condition is to terminate immediately the alleged cartel conduct. Past experience shows that sudden absence from cartel meetings may lead to suspicion and therefore to destroying evidences by the other cartel members, the company should find the appropriate measures in order to not jeopardize the effectiveness of the investigation. The second condition is the obligation of total cooperation with the national competition authority. This includes providing in time and not destroying evidence, answering every question, making every intra-company investigation possible, and not going public without the consent of the investigation body. Finally the third condition requires that the applicant company should not have destroyed evidence prior to the application and should not have disclosed the fact of its contemplated application (except to other competition authorities). [13] 

It is quite a straightforward system: "the first firm to denounce existence of a cartel receives immunity from prosecution. If the firm is not the first to denounce its existence, it gets a 50% reduction in fines. If the firm co-operates with the Commission, acknowledging its culpability, it gets a 10% reduction in fines. If, once the investigation is opened, the firm gives additional information, it gets a 20-30% reduction in fines.

This policy has been of great success as it has increased cartel detection to such an extent that nowadays most cartel investigations are started according to the leniency policy. The purpose of a sliding scale in fine reductions is to encourage a "race to confess" among cartel members. In cross border or international investigations, cartel members are often at pains to inform not only the EU Commission, but also National Competition Authorities and authorities across the globe." [14] This brings up the old Prisoner's dilemma: it is a classical multi-participant game theory problem that appears here in practice.

Here is a simplified diagram as it was a 2-party game:


Company A blows the whistle

Company A remains silent

Company B blows the whistle

whoever is first: immunity; the other: reduction of fines

A: penalty; B: immunity from penalty

Company B remains silent

A: immunity from penalty; B: penalty

both get off free

Chart: own creation

There is a huge incentive in blowing the whistle as the first one to speak goes free, but there is also the case that if no-one speaks, the cartel can continue its activity and the member companies can further take advantage of it. The members, when considering turning to the authorities, can never know whether they are first or not. This situation has caused cartels to be less effective due to the potential mistrust among members, and there are more and more cases of revealing cartel activities throughout the world. In the followings I am going to take a glance on the antitrust policies in the US since there are slight differences in the US case law regarding the regulation of anti-competitive behavior.

As I mentioned in the historical background in Chapter II, the American competition policy is called antitrust policy and is based on the Sherman Act and the Clayton Act. The Federal Trade Commission (FTC) works together with the United States Department of Justice (DoJ) Antitrust Division. The difference compared to the EU policies is that the Assistant Attorney General for Antitrust (AAG-AT) has the power to file criminal cases against willful violators of the antitrust law. The AAG-AT is appointed by the President - the current officer is Christine Varney, appointed by President Barack Obama in 2009.

Chapter V - International measures

Every state has its own authority to regulate and control market participants, but there are a few international directives that are considered above borders. OECD - Organization for Economic Co-operation and Development is an economic integration to stimulate world trade and economic progress. The OECD is a key actor in developing common principles on judging the collusion of market participants (cartels, mergers); it stabilizes common requirements in international mergers as well as safeguards and promotes the most efficient cooperation among the different competition authorities worldwide. [15] 

WTO - World Trade Organization also has guidelines and policies on the regulation of market competition. The website of the WTO describes their mission as the following: "This is one of the so-called "new issues" in the WTO: addressing how domestic and international competition policy instruments, such as antitrust or competition laws, interact with international trade. In July 2004 the General Council of the WTO decided that the interaction between trade and competition policy (in addition to investment, and transparency in government procurement) would no longer form part of the Work Programme set out in the Doha Ministerial Declaration and therefore that no work towards negotiations on any of these issues will take place within the WTO during the Doha Round." [16] 

Basically, if a cartel scandal goes public, not only the national authorities are going to conduct an investigation but also these international organizations examine the given situation in order to create the best market situation possible, without inefficiencies and market failures. Also, the main task of both organizations is that of creating a global competition policy and global regulations. Since today's world economy is highly globalised: transnational companies have dominant market presence in every field, it is necessary to have a transparent, global system of regulations. The ongoing Doha round wants to complete the task of creating a competent system of regulations.

In the following chapter I am going to examine a few cases in carteling and joining leniency programs.

Chapter VI - Cases on anti-competition behavior and antitrust penalties

As we are going to see, antitrust penalties can mount up to tremendous amounts, but there are some companies that create a fund as a precaution in which they put aside money in order to be able to pay eventual fines. Considering the huge air freight scandal in Q4 of 2010, 11 airlines were fined to a total of 800 million EUR due to cartel activity, more precisely price fixing. British Airways and Cargolux had been putting money aside and as it turned out, the actual fine fell within their provision (which was around 350 million GBP). In this case the whistleblower was Deutsche Lufthansa AG: they did not have to pay, they got immunity by joining the leniency program first. [17] 

Raising a provision to eventual fines is a behavior that shows that the given company has issues that in their opinion can be argued, so just to be sure they put aside money when the fine comes. In a rather recent case, Aalberts Industries, Europe's biggest producer of fittings used in taps and heaters won a court ruling against the European Commission's investigation overturning a 100 million EUR fine. One of the main arguments of the company can be understood based on the statement of Jan Aalberts, chief executive officer: "We never made provisions for the fine on our balance sheet because it was such a completely unfair fine." [18] 

Maybe one of the most famous cases of recent times is the so-called DRAM price fixing case. This case has gone worldwide, it started in the USA in 2002 but by 2009 it arrived in Europe and in South-East Asia as well. DRAM stands for dynamic random access memory as the cartel consisted of DRAM manufacturer companies. The cartel involved more than ten companies, including a few of the largest manufacturers on the electronic market: Dell, Samsung and Apple. The participants have been sharing secret information and were keeping prices artificially high since 1998. The whistle-blower in this case was Micron Electronics who got immunity, the other parties shared a tremendous fine of about 180 million USD and several jail convictions of their executives, but yet another slap on the face arrived when the European Commission started their investigation and inflicted a total fine of 331 million EUR. Of course one does not have to feel sorry for these companies who have an incredibly high yearly turnover that made them possible to retain their dominant role on the market as market leaders. Despite these penalties carteling continues to exist, but some kind of fear or change can be examined in the business strategy of companies in every field. Samsung for example became the co-operative party in a 2010 cartel case on LCD display products where a total fine of 650 million EUR was determined payable by six manufacturers; Samsung got immunity. [19] 

Summary and conclusion

In this paper I examined the competition policies both on national and on international level, with special emphasis on the United States and on the European Union, as these two participants have great influence on the world economy. As we have seen, competition regulation is not a modern invention; it is a necessary tool of national and international authorities in order to restrain the abuse of power and dominance on the market. Still, with these actions consumers are dependent on the providers' intentions on changing the market environment. The situation between the regulating authorities and the cartels can be compared to the classical model of the robber and the cop: the robber will always be one step ahead of the cop.

In my opinion leniency programs are a good tool on revealing cartels because as I presented the Prisoner's dilemma, it is rather difficult to make the right decision on coming out not knowing the position of the others. As a result of this many companies have chosen to betray the cartel even if they risked losing huge profits. Cartels are also called 'trusts' that indicates the most important thing that links the members together: they have to trust each other in order to keep the secret and to be able to continue cooperation that is mutually beneficiary for them. Yet, everybody acts as it is best for them, and these leniency programs very often become the best possible option on the market, because the cartel members are bothered by the fear that the other might have informed the authorities faster.

Criticism afflicts traditional antitrust policies in the current economic situation. Since today we are living in a globalised market environment, the current regulatory system is not enough. It has to go global; it has to create specific and detailed guidelines on the behavior of TNCs. But creating fully elaborated global antitrust policies that are precisely defined in every detail is the task of the national and international authorities, the basic concept has proven to be effective, they only have to build a more sophisticated system. I believe this new system might be the tool to a completely clean market environment.