Recidivism: a Commission fining policy that might not be hitting the mark

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Summary

The short version of this very long post is that the Commission’s current policy of applying the concept of recidivism to the highest level parent that exercises decisive influence over the infringing company appears to unduly punish undertakings that sell a large number of different products as compared to undertakings that sell only a small number. The likelihood of being a recidivist is massively influenced by the product range of the company and not by the propensity of the company to cartelise.

For the sake of simplicity the rest of this post assumes the existence of a multi-product firm with each product being sold in a different subsidiary.

The increase in fine for recidivism under the Commission’s 2006 Fines Notice appears to be imposed more because of the extent of the product range of the undertaking than because of the undertaking’s relative culpability (it’s propensity to participate in a cartel). Obviously, all other things being equal, an undertaking with several subsidiaries is more likely to be a recidivist than an undertaking with a single subsidiary; that would not make a recidivism uplift for the multi-product undertaking unfair. But the increased probability of being a recidivist does not increase linearly with an increase in the number of subsidiaries – it increases far more quickly. You might think that an undertaking with ten subsidiaries is ten times more likely to be a recidivist than an undertaking with a single subsidiary. In fact it is fifty times more likely.

It is this lack of linearity that makes the Commission’s current approach to recidivism dubious. The recidivism uplift is going to be applied to companies with more subsidiaries, rather than companies with greater culpability.

What follows tries to explain this using basic probability. Be warned; it is quite long.

For those happier with probabilities and tables, then attached you will find a spreadsheet – Recidivism-probabilities – where you can alter the basic assumptions and see what impact that has on the probabilities.

Here is a static table, setting out the assumptions and probabilities on which the text below is based.

Probability Equivalent to once every…
Probability of infringement per year 0.0100 100 years
Reduction in probability after first infringement 50% 0.0050 200 years
Reduction in probability after third infringement 50% 0.0025 400 years
Number of subsidiaries (assuming for simplicity one sub=one product)
1 10 38 50 100
Probability of undertaking infringing the competition rules sometime in a ten year period 9.6% 63.4% 97.8% 99.3% 99.996%
Probability of the same undertaking also infringing the competition rules in a second ten year period 0.5% 25.0% 83.2% 91.2% 99.3%
Probability of the same undertaking also infringing the competition rules in a third ten year period 0.0% 5.5% 51.1% 65.1% 91.2%

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Introduction

Many competition authorities punish repeat offenders more severely, but authorities are not consistent in what constitutes a repeat offence in terms of:
– whether a repeat offence should be measured by the product, the company, or the corporate group (the “recidivism entity”); and
– the time between the definitive finding of one infringement and the beginning of the next (the “recidivism time period”).

This post looks only at the first of these, the recidivism entity, and for the sake of brevity does not look into the recidivism time period. There are also many other aspects of recidivism policy not covered in this post – whether a cartel followed by a vertical distribution infringement should be regarded as recidivism, whether a national distribution infringement followed by a global abuse should be regarded as recidivism, whether a comparatively small cartel justifies a recidivism uplift in a comparatively large and later cartel, and so on.

Of course, punishing repeat offenders more severely is generally accepted as a good idea and is far from unique to competition enforcement. If someone breaks a law, the penalty is often supposed to both punish the offender for the particular offence, and deter the offender from committing any future offence (and deter others more generally but that’s not relevant here). So if the same offender reoffends, it is reasonable to assume that the punishment for the first offence was not sufficiently deterrent, and the punishment for the second offence should be increased.

When looking at an individual – say a bank robber – the principle is relatively straightforward. An individual who robs a bank, is then caught and punished, and then robs another bank, is a recidivist.

When applied to corporate law-breaking, it is a little more complicated. When looking at whether an offence is a repeat offence, do you look at whether the conduct was carried out by the same employee, the same division, the same legal entity, or the same undertaking? Which recidivism entity you take into account makes a big difference.

The European Commission’s policy on recidivism is not restricted to the legal entity which was involved in a cartel, but extends to the ultimate parent which exercises decisive influence over that entity, and 100% ownership leads to a presumption of decisive influence which is in practice difficult if not impossible to rebut.

A Simplified Example

So how does that policy affect (1) a single product firm as compared to (2) a corporate group with a parent and, say, 100 subsidiaries? The approach I have taken here is to assume all other characteristics of the firms are the same – so eliminating all variables other than the number of the subsidiaries. I assume that the risk of each subsidiary entering into a cartel is the same, the propensity of all of the industries to cartelise is the same, and so on. Then I look at the probability of recidivism for companies with different numbers of subsidiaries.

The Problem with Probability

One of the problems with probability is that for many people, and certainly for me, it is deeply counter-intuitive. If a roulette wheel comes up black three times in a row, I want to bet on red. But if the wheel is true, then the probability of a red after three blacks is the same as the probability of a black after three blacks. So if a roulette wheel comes up black ten times in a row, there’s a temptation to think that the wheel is rigged. But given the number of casinos and roulette wheels in the world, and spins of those roulette wheels every day, I would guess – and I haven’t even tried to work this out – that a roulette wheel hitting black ten times in a row happens every few days. (This is the same idea as an individual winning a lottery twice; it’s very unlikely to happen to any one individual, but given the number of lotteries and players in the world, it’s also very likely to happen to someone.) Thinking otherwise is often called the gambler’s fallacy. This is how casinos make their money, and is one of the reasons I don’t gamble.

The counter-intuitive nature of probability is one of the reasons that in the rest of this post, I try and express the probabilities in different ways: some readers may find one type of example easier to grasp than another. I express the probabilities as a fraction of 1 (1 being certainty), as a percentage, and as a relationship between a large number of – hypothetical – companies and the subset of those companies that would, probabilistically, engage in cartels. For those readers with a better grasp of probability theory than I, this will likely be annoyingly repetitive. My apologies.

A Single Product Company

Take a single-product company’s likelihood of entering into a cartel. There are many factors that might influence this – the type of industry, the health of the economy as a whole, the health of that particular industry, the corporate culture, the company’s emphasis on competition compliance, and so on. All of these could be combined to come up with a measure of how likely that company is to engage in a cartel in any given year.

A hypothetical probability of it entering into a cartel

In the real world there is no way to look at any company and come up with an even vaguely reliable estimate of such a measure. But for the purposes of this post, the precise number does not really matter. All that matters is that we imagine a hypothetical single product company, attribute to it a probability, and attribute that same probability to each product-selling subsidiary of the 100 product undertaking. That gives you an indication of how, controlling for all other factors, the likelihood of companies entering into cartels is related to the number of products that that company sells. In particular this controls for their propensity to cartelise.

The first cartel

So, for example, a company that manufactures widgets might, taking into account all of the factors above, have a probability of 0.01 of engaging in a cartel in a given year. In the same way that rolling a dice gives a 1 in 6 (roughly 0.17) chance of rolling a 6, a probability of 0.01 is a 1 in 100 chance. After six rolls of the dice, you are very likely to have rolled a six; after one hundred years, our widget company is very likely to have engaged in at least one cartel.

Now 1 in 100 years seems a pretty low probability of entering into a cartel (from the perspective of a competition authority, if a company only engaged in one cartel every one hundred years, then they’re probably quite law-abiding). It seems a low estimate for many companies, particularly as very few companies last for a hundred years. But I’m trying to use numbers that are the least favourable to the conclusion that I draw at the end. I should note though that is one of the assumptions in this post I am most concerned about. Some companies seem to have sufficiently good compliance that they simply do not enter into cartels. If the starting assumption is that perfect compliance is possible, then the conclusions of this post may well be completely wrong.

If our single-product company has a probability of 0.01 of entering into a cartel in any given year, then over ten years, the probability of it entering into at least one cartel is about 0.096 or 9.6%. Roughly a 1 in 10 chance. So far, so, perhaps, obvious.

Put another way, if we take 10 000 single-product companies with the same characteristics, then roughly one in ten of them – around 960 – will enter into at least one cartel in any ten year period. The reason for using such a large number of companies as a point of comparison will, I hope, become clear.

The second cartel

Let’s assume that our company is one of the 960. It enters into a cartel sometime in that ten year period, and is caught and punished. As a result, it works hard at educating its employees about the competition rules, and successfully halves its chances of entering into a cartel in the future. So from a 0.01 probability of entering into a cartel – once in a hundred years – it then has a 0.005 probability – once in two hundred years. All of the other 959 companies do the same.

Bear with me.

What are the chances that our company – or any of the other 959 companies – having entered into a cartel in that first ten year period, and then having improved its compliance, nevertheless also enters into at least one cartel in a second ten year period? About 0.0047, or 0.47%. That’s a pretty low percentage; at about 200/1 against, not something anyone would likely bet on.

We started with 10 000 companies. Of these, 960 would enter into that first cartel in the first ten year period, and 47 of those 960 would enter into a second cartel in that second ten year period.

Round three.

The third cartel

Let’s assume that our cartel-prone company – and the 46 others – is caught, again, and punished for this second cartel. And they redouble their compliance efforts. So from a 0.005 probability of entering into a cartel in any given year, any one company now has a 0.0025 probability. One in four hundred years.

So given this further improvement in compliance, what are the chances of our widget company messing it up once again, and entering into at least one more cartel in a third ten year period? About 0.0001 or 0.001%. Or, of the original 10 000 companies, of which 960 entered into a first cartel, of which 47 entered into a second cartel, only 1 entered into the third.

Probability of cartelizing Equivalent to…
First Cartel 9.56% 960 companies out of 10 000
Second Cartel 0.47% 47 companies out of 10 000
Third Cartel 0.0116% 1 company out of 10 000

That looks good. Our single product company – and its 9 999 equivalent companies – has the incentive to keep improving its compliance, and keep reducing the chances of it engaging in cartels. On the above numbers, only 1 in 10 000 will enter into three cartels.

So much for a single-product company. Most companies produce more than just a single product. As we will see, the more products are produced (assuming for simplicity that each product is produced in a separate subsidiary), the greater the likelihood of a company being a recidivist. But the increase is far from linear.

A 100 Product Company

From a single-product company that just produces widgets, let us take an undertaking that produces one hundred different products, each in a different subsidiary.

The same hypothetical probability

Let us assume that the likelihood of each subsidiary entering into a cartel is the same as the widget company described above – 0.01. Let us also assume that if a subsidiary is caught in a cartel, then not only does that subsidiary increase its compliance efforts, but so does the entire group – which is exactly what a competition authority would want to happen.

Let us also assume that whether one subsidiary does not make it any more or less likely that another subsidiary will also enter a cartel (in terms of probability, that they are independent events), save for the undertaking-wide increase in compliance efforts after the fact.

The first cartel

In a ten year period, what are the chances of this 100-subsidiary company entering into at least one cartel in at least one of its subsidiaries? It is probably no surprise that it’s almost certain – over 99.99% (as opposed to about 9.6% for the single-product widget company). So if we imagine 10 000 one hundred product companies, just as we imagined 10 000 single product companies, then in a ten year period, 9 999 of those one hundred product companies will enter into a cartel (as opposed to about 960 single product companies).

Not so good for the 100-subsidiary company.

Note that the probabilities here are roughly linear – a 100-subsidiary company has roughly 100 times the probability of entering into at least one cartel than a one subsidiary company. The linearity breaks down, however, as soon as we look at recidivism.

Let us assume that the 100-subsidiary company puts in place the same additional compliance efforts as the single-subsidiary company, and does so across all 100 subsidiaries. It works just as hard at educating its employees about the competition rules (harder even, given that it has to roll out this compliance in 100 subsidiaries), and successfully halves any subsidiary’s chances of entering into a cartel in the future. So from a 0.01 probability of entering into a cartel – once in a hundred years – each subsidiary has a 0.005 probability – once in two hundred years. (Just as the single subsidiary company above.)

So what are the chances of a 100-subsidiary company entering into at least one cartel in the second ten year period?

The second cartel

We obviously expect to see the likelihood of it engaging in a second cartel after the first to be much less likely. For our single-subsidiary company above, the probability of it engaging in the first cartel was 9.6%, and a second cartel after the first was only 0.47%. But for a 100 subsidiary undertaking we only get a decrease from 99.99% to 99.33%. For every 10 000 undertakings, 9999 would enter into a first cartel, and 9933 would enter into a second. Not great. And bear in mind that this 100 subsidiary undertaking’s compliance efforts in every one of its subsidiaries are equal to that of the single product company.

The third cartel

OK, but what if our 100 subsidiary company redoubles its compliance efforts once again, just like the widget company? What are the chances that it will enter a third cartel in a third ten year period? 91.2%.

If we were faced with 10 000 undertakings, each of which had 100 subsidiaries, then 9999 would enter into a first cartel, 9933 would enter into a second, and 9120 would enter into a third.

Comparing the single product widget company and the 100-subsidiary multinational:

Probability of cartelizing Equivalent to…
First Cartel 9.56% 99.99%
Second Cartel 0.47% 99.33%
Third Cartel 0.0116% 91.2%

Tentative Conclusions

If the law should try to treat like cases alike and different cases differently, then it’s worth asking how compliant would the 100 subsidiary company have to be at the start, to put their probability of entering the third cartel down to the level of the single product company? Roughly 0.00022, or a cartel every five thousand years. Or, if we assume that a company with that kind of compliance record can’t improve it further, and its compliance therefore cannot not improve after each infringement, then 0.00011, or a cartel every ten thousand years. That is a rather tough objective.

You can look at the same numbers from a different perspective. If we again keep the probability of entering into a cartel at 0.01 as for the single product widget company, how many subsidiaries would a company need for it to become more likely than not (a probability of more than 50%) that a multi-subsidiary company will enter into three cartels on the terms described above? About 38.

You can change the assumptions, and I encourage you to do so. You can download the spreadsheet and change the probabilities for the first, second and third cartels, and change the number of subsidiaries, and see what difference that makes.

There may of course be good reasons why larger undertakings should be held to a higher standard and exposed to a greater risk of a fines increase for recidivism: larger corporations can better afford compliance programmes, training and monitoring, for example. But the way the Commission’s recidivism policy operates doesn’t put a slightly higher standard on multi-product companies, it puts an much higher standard on them, possibly an impossibly higher standard.

But going to the opposite extreme, it is fairly clear that a recidivism policy based solely on the product itself would be too narrow. If a CEO was personally implicated in three cartels, then the fact that the cartels were in three different subsidiaries of his/her 100-subsidiary undertaking should not be enough to escape a recidivism uplift for the group as a whole.

A properly drafted recidivism policy that truly identified recidivists, and properly reflected propensity to enter into cartels would have to look at a range of factors. But ignoring the number of products sold by a company means that the current Commission policy when assessing recidivism seems to punish inappropriately multi-product undertakings.

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Fines, “small” companies and the 10% cap

Do the fining rules treat small companies badly?  This is an occasional criticism of the 2006 Guidelines on Fines.  Is it accurate? Let’s take an intentionally simplified example.

Nine companies each have value of sales of 10m euros per year in a product which they cartelise. All are equally culpable (no aggravating or mitigating circumstances to take into account), save for the duration of their participation in the cartel – three had a short duration, three medium, and three long. The only other relevant difference between the companies is their total worldwide turnover; similarly three had a small turnover, three medium, three long.

This gives us nine different companies which we can group – for example – by their worldwide turnover, the duration of their participation, or their theoretical fine.

Let’s assume that the theoretical fine is based on their cartelised sales * duration * variable amount of 15%, plus the entry fee (15% of their cartelised sales). Each has the same liability and impact on the market for each year of the cartel; in terms of harm caused, only the duration of their involvement differs.

Continue reading “Fines, “small” companies and the 10% cap”

Speaking Engagements

I have two speaking engagements in April, both on cartels.

The first is for the American Bar Association: Slicing the Pie: Defining the Scope of an International Cartel: April 28, 2014 12:00PM to 1:30PM (EST) / 6:00PM to 7:30PM (CET)

The second is at the IBC Advanced EU Competition Law event in London on 29 & 30 April, where I’ll be speaking with Johan Ysewyn on recent cartel developments. IBC bills the conference as “The ultimate review of key developments in EU competition law.” If anyone is organising a penultimate review of developments, please let me know.

Inability to pay and significant loss of asset value

The European Commission’s positions on inability to pay competition fines, and on the failing firm defence under the merger regulation are superficially different, but the underlying policy concern is the same.

The Commission’s 2006 Fining Guidelines envisaged the possibility that some fines ought to be reduced if a firm is unable to pay:

“35. In exceptional cases, the Commission may, upon request, take account of the undertaking’s inability to pay in a specific social and economic context. It will not base any reduction granted for this reason in the fine on the mere finding of an adverse or loss-making financial situation. A reduction could be granted solely on the basis of objective evidence that imposition of the fine as provided for in these Guidelines would irretrievably jeopardise the economic viability of the undertaking concerned and cause its assets to lose all their value.” (emphasis added)

This last element, that a fine should not cause the assets “to lose all their value” was clarified in an Information Note jointly agreed by Commissioners Almunia and Lewandowski:

“8. With respect to the condition that the company’s assets have to lose “all their value”, it has become apparent that a literal interpretation of this wording would rather lead to a systematic rejection of all ITP claims since individual assets practically never lose completely their value, even if the company that participated in the anticompetitive practice goes bankrupt (because the assets normally will retain a certain operational and resale value). The Commission therefore interprets this condition as requesting that the fine would not only be likely to lead to the bankruptcy of an undertaking as such, but also that it would cause its productive assets to lose “significantly” their value. This would be the case if the bankruptcy would lead to the disappearance of the undertaking as a going concern (because of dismantling and/or closure), its jobs being lost and the assets (property, buildings, machinery etc.) being sold separately at substantially discounted prices. Conversely, there would be no significant asset loss if there are clear indications that the undertaking will be acquired and its business will be continued as a going concern (i.e. without job losses, etc.) by another company, even if the infringing undertaking as a legal entity would declare bankruptcy.” (emphasis added)

This makes clear that bankruptcy in itself is not a reason for reducing or eliminating a fine. Only if the undertaking would not continue as a going concern should the Commission accept an inability to pay application. If a competition fine would lead to the removal of the firm as a competitive force on the market, then competition on the market may best be served by reducing or not imposing the fine.

The Commission may be faced with a similar problem under the Merger Regulation. If a merger would lead to a significant impediment to effective competition, but one of the firms may – absent the merger – fail, then competition on the market may best be served by allowing the merger. This is usually referred to as the failing firm defence.

However, the wording of the failing firm defence under the Merger Regulation is a little different to the wording in relation to a firm being unable to pay a competition fine. In the Horizontal Merger Guidelines, the Commission sets out three criteria which must be fulfilled for the failing firm defence to be met:

“The Commission considers the following three criteria to be especially relevant for the application of a “failing firm defence”. First, the allegedly failing firm would in the near future be forced out of the market because of financial difficulties if not taken over by another undertaking. Second, there is no less anti-competitive alternative purchase than the notified merger. Third, in the absence of a merger, the assets of the failing firm would inevitably exit the market.” (emphasis added) (at paragraph 90).

The Commission points out in the next paragraph that this isn’t an exception to the merger control rules, but rather an application of the principle that there has to be, “causality between any given merger and any deterioration of competitive conditions in the market that can be expected to occur.’ You could also see this as an application of the principle that the competition rules should not decrease competition on a market. The Commission should not prohibit a merger – or impose a cartel fine – that would weaken competition on a market.

Notwithstanding this common aim, the criteria set out are rather different.

In the inability to pay scenario, the Commission refers to causality plus the potential loss of asset value; in the failing firm scenario, the Commission mentions causality, the lack of alternative solutions (not relevant to a cartel or other antitrust fine) and the exit of productive assets from the market. The latter formulation with its focus on the exit of productive assets from the market seems better aligned with what the public policy should be: if productive assets are being lost to society, then society is worse off; if a shareholder of a company that has been involved in a cartel simply loses the value of its investment, then that is a problem for the shareholder, not for society. That an undertaking goes bankrupt is not in itself a loss of productive assets to society; an undertaking ceasing to be a going concern is more likely to lead to a loss of productive assets to society; better yet, however, would be an explicit recognition that the policy objective underlying inability to pay is the loss of productive assets, for which an undertaking ceasing to be a going concern is at best an imperfect proxy.

This is certainly hinted at in the emphasised section above in the Almunia / Lewandowski information note that the underlying concern is in fact the loss of productive assets – in the reference to the undertaking not surviving as a going concern or the assets being sold separately – and this is a useful clarification of the 2006 Fines guidelines.

Perhaps if there is ever to be a revision to the Fines Guidelines, this hint could be taken up more fully, and the language on inability to pay aligned more closely with the language on failing firm.

[Update: 18 April 2014: this post has been slightly rewritten to – hopefully – make the flow of the argument clearer. No change of substance or argument was intended.]