THE LAW AND ECONOMICSOF COLLUSION

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Overview

• Context: At an industry convention, a competitor complains that“competition is much too tough.” How should you reply?

• Concepts: antitrust, competition policy, price fixing, civil andcriminal offense, leniency

• Economic principle: crime does not pay

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Outline

• Collusion: US and EU law

• Leniency programs

• Facilitating practices

• Allowed horizontal agreements

• Cases

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Outline

• Collusion: US and EU law

• Leniency programs

• Facilitating practices

• Allowed horizontal agreements

• Cases

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Motivating example: lysine

• How the cartel worked

• How the DoJ found out about it

• Economic, legal, and personal ramifications

• Watch video from Fair Fight in the Marketplace

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Price fixing and related illegal practices

• Price fixing is illegal

− Criminal offense in U.S. (Sherman Act)

− Civil offense in Europe (Articles 101, 102 of Treaty of the EU)

• There may be exceptions and exemptions, e.g.:

− Some sports leagues

− European airlines until early 1990s

• Related forms of collusion

− Territorial or no-customer-poaching agreements

− Capacity reduction

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History of anti-price-fixing law: US

• US, late 1800s: price instability led to formation of cartels

• In addition to price stability, this also brought about high prices

• Sherman Act, 1890. Sections 1 and 2 prohibit such contracts.Felony (prison sentences).

• Some practices per-se illegal. Otherwise, rule of reason is applied.

• Important precedents: GE and Westinghouse, Airline tariffpublishing (non-explicit collusion)

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Top recent DOJ fines

Sherman Act Violations Yielding a Corporate Fine of $10 Million or More

Defendant (FY) Product Fine ($ M) Country

F. Hoffmann-La Roche, Ltd. (1999) Vitamins $500 Switzerland

LG Display Co., LtdLG Display America (2009)

LCD panels $400 Korea

Societe Air France and KoninklijkeLuchtvaart Maatschappij, N.V. (2008)

Air Transportation(Cargo)

$350 France (SAF)Netherlands (KLM)

Korean Air Lines Co., Ltd. (2007) Air Transportation(Cargo & Passenger)

$300 Korea

British Airways PLC (2007) Air Transportation(Cargo & Passenger)

$300 UK

Samsung Electronics Company, Ltd.Samsung Semiconductor, Inc. (2006)

DRAM $300 Korea

BASF AG (1999) Vitamins $225 Germany

CHI MEI Optoelectronics Corporation(2010)

LCD panels $220 Taiwan

Hynix Semiconductor Inc. (2005) DRAM $185 Korea

Infineon Technologies AG (2004) DRAM $160 Germany

Source: http://www.justice.gov/atr/public/criminal/sherman10.html

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History of anti-price-fixing law: EU

• EU Treaty Article 101 (formerly Article 81, formerly Article 85 ofTreaty of Rome). Initial precursor: Treaty of Paris (1951).

• Important precedent: Wood pulp (jurisdiction)

• National regulations, esp. UK (civil and criminal offense)

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Public and private litigation

• Almost 90% of antitrust enforcement in U.S. through private civilsuits; almost none in the European Union.

• Clayton Act: treble damages (private litigation quite attractive)

• Example: Sun Microsystems 2002 private federal antitrust lawsuitagainst Microsoft: using monopoly in PC operating systemsmarket to undermine the success of Sun’s Java technology.

• Later Sun also filed a complaint with the European Commission

• Former EC Commissioner Mario Monti: Europe should considerallowing U.S.-style private lawsuits

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Outline

• Collusion: US and EU law

• Leniency programs

• Facilitating practices

• Allowed horizontal agreements

• Cases

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Leniency programs

• First introduced by DOJ in 1978

• Major revision in 1993

− Less legal uncertainty

− Automatic amnesty (still discretionary if report received after aninvestigation under way)

− Significant increase in activity: from 1/year to 2/month reports

• Similar programs in UK, EU, Japan, etc

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What determines fines?

• Study by Connor based on US plea bargains.

• Average fine discount w.r.t. maximum fine: 70%

• Fine discounts lower for 2nd, 3rd, etc. plea bargain in each case

• No relation between fine and harm produced by firm

• Fines depend greatly on cartel characteristics: higher fines forinternational cartels, bid-rigging schemes

• Leniency higher during Bush II than during Clinton

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Evaluating leniency programs

• Performance measures

− Fines

− Number of cases

• Fairness

− Example: Diana Brooks and Christopher Davidge

• Over-enforcement

− Private suits

− No double jeopardy (why so few in Portugal?)

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Mini-case: BA and VA

• Why did BA call VA?

• Are fuel surcharges illegal? Is it illegal for both airlinesto set the same surcharge?

• How would you structure a leniency program?

• Is it fair that two firms are treated differently for thesame crime?

• Are you in favor or against leniency programs?

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Outline

• Collusion: US and EU law

• Leniency programs

• Facilitating practices

• Allowed horizontal agreements

• Cases

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Facilitating practices

Def: institutional features that make collusion easier

• Price transparency (published prices)

• Most favored customer clause

• Meet the competition clauses

• Examples:

− GE and Westinghouse and DuPont and Ethyl

− Ready-mixed concrete in Denmark

− Federal Election Campaign Act and Medicaidreimbursement rules

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Ready-mixed concrete in Denmark

Jan-94 Apr Jul Oct Mar-95 Jun Nov

300

350

400

450

500

550Average 10-MPa Concrete Prices in Arhus

Time

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Mini-case: GE and Westinghouse

• What was GE thinking in 1963?How did Westinghouse react and why?

• What was the DOJ case in 1974?How would they have fared in court?

• How does the current legal doctrine treat facilitatingpractices?

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Outline

• Collusion: US and EU law

• Leniency programs

• Facilitating practices

• Allowed horizontal agreements

• Cases

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Non-price agreements

• Research related agreements

− Common standards

− Joint R&D

− Patent pools

• Information exchange

− Industry associations

− Demand and cost data

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Exemptions and exceptions

• Major League Baseball; other sports in US

• English Premier League

• European airlines until 1990s

• Export cartels

• Joint marketing programs

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Outline

• Collusion: US and EU law

• Leniency programs

• Facilitating practices

• Allowed horizontal agreements

• Cases

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Wood pulp

• Wood pulp prices are announced at regular intervals;competitor prices tend to move in tandem.

• European Economic Community (EEC) initiatesinvestigation (1977)

• Non-EEC defendants (Finland, US and Canada)challenge to jurisdiction

• European Courts side with Commission on jurisdiction:effects doctrine (1988)

• Courts strike down collusion case: price parallelism canbe viewed as the result of collusion only if there is noother explanation for it

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Sotheby’s and Christie’s

• The companies: both founded in England, offices inmany countries. Close to 100% art auction market

− Sotheby’s: based in NY; $3bn turnover

− Christie’s: based in London; private since 1999

• Revenue sources: fees over “hammer” price

− Seller’s (or vendor’s) commission

− Buyer’s premium

− Vary by amount, type of auction; special deals

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Sotheby’s and Christie’s

• After late 1980s boom, market collapsed in early 1990s(Japan economic crisis → drop in demand)

• Fierce competition, low profits

• November 1992: Sotheby’s announces increase incommissions; Christie’s does the same one month later

• March 1995: Christie’s announces increase in sellers’fees; Sotheby’s does the same one month later

• June 1996: UK OFT initiates informal inquiries

• June 1997: DoJ subpoenas files from the two houses

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Investigation, leniency, conviction

• 1998: Francois Pinault buys Christie’s for $1.2 billion.Christopher Davidge replaced as CEO

• Late 1999: Christie’s lawyers prepare for governmentinvestigation, uncover evidence of conspiracy

• January 2000: Christie’s agrees to amnesty conditionalon Davidge cooperating with DOJ. Davidge paid largesum for doing so

• Early 2000: Ms. Brooks receives permission fromSotheby’s to do the same but is too late

• September 2001: Ms. Brooks and Sotheby’s pleadguilty (on seller’s commissions)

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Court findings

• Mr. Taubman and Sir Anthony met on 12 occasions atTaubman’s London flat, New York residence

• Ms. Brooks and Mr. Davidge met repeatedly, reportingto Taubman and Tennant. JFK meeting

• Agreement was established on common fees, nocustomer poaching, no special deals to customers (withexceptions)

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Court sentences

• April 22, 2002: Mr. Taubman sentenced to a year anda day in prison and fined $7.5 million

• April 29, 2002: Diana Brooks sentenced to three yearsof probation, including six months of house arrest;fined $350,000 and ordered to perform 1,000 hours ofcommunity service

• Mr. Davidge marries former Chritie’s employee inIndia. Guests paid first-class tickets

• Sir Anthony Tennant refused to testify in US, couldnot be extradited from UK. Died in 2011

• Also: civil suit

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Sotheby’s and Christie’s: takeaways

• Price fixing is not limited to commodities

• Top management liability conditional on awareness

• Communication isn’t always necessary to maintain highprice equilibrium

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Chocolate price fixing

• Class-action suit in Canada (2008)

− Chocolate majors conspired to increase prices

− Discussions at trade shows and association events

− Total settlements C$23.2m(from Mars’ C$3.2m to Nestle’s C$9m)

• Mars and Nestle still face criminal charges(Canada Competition Bureau).Hershey off the hook through leniency program

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Chocolate price fixing

• Class-action suit in US

Nothing scandalous or improper has beendiscovered within our borders, and no evidencepermits a reasonable inference of a price-fixingagreement.

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Chocolate price fixing

• German Cartel Commission (2013)

− Fines over e60m ($82m)

− Mars escaped financial penalty as one of the initialwhistleblowers

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Chocolate price fixing: takeaways

• Transporting evidence across jurisdictions

• Leniency is jurisdiction specific

• Private suits

• Paying damages in class action suits

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eBooks

• Wholesale model (Amazon): publisher sets price w ,retailer sets price p and pays w to publisher.

• Agency model (Apple): publisher sets retail price p,retailer keeps α p. Apple’s α = 30%

• Amazon’s ebook price point: $9.9

• Apple’s proposal to publishers: tiers up to $14.99

• Also: Apple forces MFN clause: if publisher sells forless than $14.99, Apple has the right to lower priceaccordingly

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eBooks

• Steve Jobs’ idea: help publishers push Amazon toagency model. In fact, require publishers to movee-tailers to agency.

− Apple’s benefit avoid retail price competition: iPad willbeat Kindle on device quality

− Publisher’s benefit: fix Amazon’s low pricing problem

• But α = 30% is very high!

• Hachette, Penguin, Random House, HarperCollins,Macmillan and S&S accept; Random House declines

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eBooks

• DoJ’s case (April 2012): Apple’s proposal is a schemeto increase prices in a coordinated manner

• Hachette, HarperCollins, Simon & Schuster, Macmillanand Penguin deny wrongdoing but agree to settle(December 2013)

• Pay $166 million to customers (call 1-866-621-4153)

• Federal judge finds (July 2013) Apple violated antitrustlaw in helping raise the retail price of e-books

• Case is on appeal

• Note: decision does not imply that agency model orMFC clauses are illegal

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eBooks: takeaways

• Collusion is not limited to smoke-filled room pricefixing: facilitating practices can be deemedanti-competitive (cf GE and Westinghouse)

• Decision does not imply that agency model or MFCclauses are illegal per se (difference w.r.t. rule ofreason)

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eBay hiring

• DoJ files a series of civil antitrust suits against Adobe,Apple, eBay, Google, Intel, Intuit, Lucasfilm, Pixar.

• Claim: “no cold call” agreements. Specifically, seniorexecutives of eBay and Intuit agreed not to recruitemployees from each other

• District court finds agreement, if proven, constitutesnaked horizontal market allocation agreement:manifestly anticompetitive, per se unlawful

• Settlements reached with various companies, mostrecently eBay (May 2014)

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eBay hiring: takeaways

• Illegal horizontal practices are not restricted to sellers’actions (monopsony power)

• Illegal horizontal practices are not restricted to settingprices (e.g., limit competition clauses)

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Synthetic rubber

• EC fines ENI and Versalis e272.25 million forparticipating in the synthetic rubber cartel (Nov 2006)

• Fine includes a 50% increase due to recidivism: firmshad already participated in Polypropylene (1986) andPVC II (1994) cartels

• In January 2008, Bayer and Zeon are also fined forcartelization.

− Bayer’s and Zeon’s fines are reduced by 30% and 20%,respectively, under the EC leniency program

− However Bayer’s fine is increased by 50% because it hadbeen fined for cartel activity in a previous Commissiondecision.

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Synthetic rubber: takeaway

• Wishful thinking

This is the fourth cartel decision in the syntheticrubber industry in just over 3 years. I hope thatthis is the last. Buyers of synthetic rubbershould be concerned about how much thesecartels have cost them. And shareholders shouldbe concerned about how much the fines havecost them. — Competition Commissioner NeelieKroes

• Cartels on commodities abound, will probably neverend (cf Adam Smith)

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The Libor scandal

• To set Libor and Euribor rates, banks submit rates atwhich they would be prepared to lend money to oneanother. Then British Bankers’ Association (BBA)drops the four highest and four lowest, averages theremaining into one rate — LIBOR

• Evidence that traders benefited from falsely reportedrates. Net lenders ⇒ tendency to push rates up

• In December 2013, EU fines group of global financialinstitutions a combined e1.7 billion ($2.3 billion) tosettle charges (largest combined fine in EC history)

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The Libor scandal

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Overall takeaways

• Big temptation to agree with rivals on price increases

• Crime does not pay: fines and jail sentences are common

• Leniency programs have made it worse for firms

• Explicit and implicit collusion; per se illegality and rule of reason

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