The year 2014 promises to be another year where corporate purchasing departments strive to keep costs down while vendors attempt to increase margins. In this marketplace tug-of-war it occasionally happens that vendors will reach out to their competitors and agree to end “ruinous competition” and fix “fair prices.” But, since the Sherman Antitrust Act was passed in 1890, such collusion is illegal, whatever the justification imagined by competitors. While vendor collusion may not be an everyday occurrence, price-fixing and bid-rigging continue to keep antitrust enforcers and class action lawyers very busy. Therefore, when reviewing bids and prices received from suppliers, the warning commonly seen on public transportation is also apt for purchasing professionals: “If you see something, say something.”
Coincidence or Collusion?
Price-fixing is an agreement among competitors to raise, fix, or otherwise maintain the price at which their goods or services are sold. Price-fixing agreements may, but do not always, involve setting identical prices. In fact, identical prices, like identical bids, are usually too obvious. Instead, when vendors collude, they often agree to respect each other’s customers, with one or more vendors quoting an intentionally high price. This complementary bidding creates the appearance of competition (and helps avoid detection) while raising prices and controlling the outcome. Not every competitor needs to be a member of a cartel for the collusion to be illegal. Some fringe competitors may lack the power to disrupt a cartel because of quality issues or limited capacity. And, even the most successful conspiracy usually involves some “cheating.” As prices rise, the lure of additional profits can become too tempting. Cartel members may cut prices and take additional market share when they think they can do so without being detected by other cartel members. Illegal cartels are not always obvious, but an experienced and knowledgeable purchasing professional can often see telltale signs.
Are cartels more likely to be found under certain market conditions? Collusion is more likely to occur if there are few sellers in the market. The fewer sellers there are, the easier it is to agree on prices, bids, customers or territories. Collusion may also occur when the number of firms is fairly large, but a small group of major sellers controls a large portion of the market. When the product being sold is standardized, collusion is also more likely because it is much easier for sellers to agree on a price than it is to control for other forms of competition such as design, quality or product features. Also, cartels are sometimes borne out of desperation—overcapacity and falling prices sometimes drive executives to seek the illegal solution of collusion. Finally, it is easier for cartels to form if competitors know each other well through trade associations or other venues. It takes a certain level of trust to form a cartel since a crime is being committed.
What should a purchasing professional concerned about collusion look for? A change in pricing patterns, such as an industrywide elimination of discounts or price protection, could indicate collaboration among sellers. Purchasers should also pay attention to increases in prices that don’t seem attributable to increases in cost inputs or other market conditions. Salespersons may sometimes make a remark that subtlety (or directly) indicates that suppliers are talking to each other. Additionally, collusion by a multiproduct supplier in one product market often indicates a culture of collusion that may affect the company’s other products. None of these factors standing alone mean that collusion is ongoing, but they may be cause for concern and further inquiry. A purchasing professional who is experienced in a given market often has an intuitive sense whether collusion may be afoot. The best strategy to use if pricing or bids seem to be noncompetitive is to ask your vendors questions. The answers may alleviate any concern of collusion. But, if the answers (or non-answers) still leave you scratching your head, wondering: “Hm, coincidence or collusion?” it may be best to talk to in-house counsel to determine if further investigation is warranted.
Finally, why should a purchasing professional be concerned about possible collusion? The goal of a cartel is to raise prices, and often they are quite successful in doing so. If a cartel is exposed, victims are entitled to damages of up to three times the overcharges. Also, when competition is restored, prices fall back to a competitive level. Cartels may not be commonplace, but when they do occur they can last for a sustained period of time and cause substantial overcharges.
Some Guidance on Purchases from Foreign Suppliers
The Sherman Act applies to domestic, and in some cases, foreign, commerce. Purchases from foreign suppliers may merit special attention. In the past year, for example, nearly every corporate defendant in criminal price-fixing cases brought by the U.S. Department of Justice’s Antitrust Division was a foreign entity. This is not to suggest that foreign suppliers may be more corrupt or less ethical than domestic ones. As noted above, however, because the Sherman Act was passed in 1890, domestic businesses have had well over 100 years to instill a culture of competition. Cartels may be more likely to form overseas than in the United States if foreign companies lack a strong competition compliance program that not only warns executives of the dangers of meeting with competitors, but also reduces the opportunities to do so without counsel present. While most countries have now enacted competition legislation similar to the Sherman Act, in many cases these are fairly recent developments and the penalty for price-fixing may be only a fine against the company. In the United States, price-fixing and bid-rigging carry stiff penalties including prison sentences of up to 10 years and fines of hundreds of millions of dollars. Finally, until fairly recently, some governments, especially in Asia, encouraged companies within industries to cooperate with each other to deal with problems like overcapacity. The “creative destruction” of capitalism is a relatively new phenomenon in some parts of the world. Domestic conspiracies to fix prices still exist, of course, but foreign cartels have dominated the recent news.
A significant recent foreign cartel case resulted in a $162 million jury verdict against Chinese manufacturers of vitamin C for price-fixing. This case was notable because the plaintiffs, American purchasers, were able to obtain enough evidence to prove the existence of the cartel, which operated exclusively in China. Also, the defendants argued (with the support of the Chinese government) that they were immune from suit because they collaborated at the direction of the Chinese government. The court and the jury both rejected this “sovereign compulsion” argument and found the defendants willingly fixed the price at which they sold vitamin C to buyers in the United States. The success of the plaintiffs in this case may encourage similar actions.
The Reach of the Sherman Act to Foreign Cartels
Section 1 of the Sherman Act outlaws agreements “in restraint of trade or commerce among the several states, or with foreign nations.” In 1982, Congress passed the Foreign Trade Antitrust Improvements Act of 1982 (FTAIA), which defines the extraterritorial reach of the Sherman Act and limits the situations in which U.S. antitrust law applies to foreign conduct. In particular, foreign conduct may fall under the Sherman Act if it “involves import trade” or “has a direct, substantial, and reasonably foreseeable effect” on U.S. domestic or import commerce. These are known as the “import commerce exception” and the “domestic effects” exception.
In a case like the Chinese vitamin C case, application of the Sherman Act is simple: The goods that were subject to the price fix were imported directly into the United States by the companies that formed the cartel. The import exception to the FTAIA applied. But, the application of the FTAIA can be more complicated. Suppose a foreign cartel fixed the price of widgets, but sold those widgets to distributors outside the United States who, in turn, shipped the product to the United States? Or, suppose foreign producers fixed the price of a product in Asia and Europe, but prices in the United States rose as a result of the collusion elsewhere? Can U.S. purchasers sue for damages? These are hot issues currently in appellate courts and the Supreme Court may eventually need to address the scope of the FTAIA.
The U.S. Court of Appeals for the Third Circuit case of Animal Science Products v. China Minmetals, No. 10-2288,is a leading case on the application of the FTAIA. In Animal Science, the plaintiffs were domestic purchasers of magnesite and the defendants were Chinese producers of magnesite. The district court had dismissed the complaint, but allowed the plaintiffs to amend “to provide the court with factual proof establishing that the defendants were acting as ‘importers.’” Rather than amend the complaint, the plaintiffs appealed. The Third Circuit stated that being a direct importer may satisfy the import trade exception of the FTAIA but “it is not a necessary prerequisite.” The court held that the FTAIA imposes a substantive element of a Sherman Act offense and that the relevant inquiry is “whether the defendants’ alleged anti-competitive behavior was directed at an import market … or, to phrase it slightly differently, the import trade or commerce exception requires that the defendants’ conduct target import goods or services.”
The issue of whether a company must itself directly import into the United States for the Sherman Act to apply is currently before the Ninth Circuit in AU Optronics v. United States, Nos. 12-10492, 12-10493, 12-10500, 12-10514. In a criminal case, AU Optronics and several of its executives were convicted of fixing the prices of LCD panels that are used as screens in computers, smartphones and many other electronic devices. Some of the LCD panels that were subject to the price-fixing were imported directly into the United States, but the vast majority were used to assemble devices overseas. The defendants argued that the FTAIA should be construed narrowly and the Sherman Act should apply only where the product that was the subject of the price-fixing is imported directly into the United States. In the defendants’ view, sale and assembly overseas into another product should prevent the Sherman Act from reaching the price-fixing. The U.S. Department of Justice argued that the Sherman Act applied because the defendants’ conduct “had a direct, substantial, and reasonably foreseeable effect” on U.S. domestic or import commerce. The DOJ pointed out that U.S. consumers would be vulnerable to price-fixing if defendants could fix prices on goods imported into the United States, but simply add a step in the assembly or distribution chain to immunize themselves from Sherman Act prosecution. The Ninth Circuit should decide the case shortly.
The Second Circuit is currently considering the application of the FTAIA to a different set of facts in Lotes v. Hon Hai Precision Industry, 13-2280. In Lotes, the plaintiffs allege that the defendants monopolized the market for USB connectors in China by refusing to adhere to intellectual-property licensing commitments. Manufacturers in China purchase the USB connectors, incorporate them into motherboards, and sell the motherboards to computer manufacturers. All the sales and assembly of the components take place in China with finished computers being sold in the United States. The district court found that the anti-competitive conduct created ripple effects on markets in the United States, but held that the effects “are simply too attenuated to establish the proximate causation required by the FTAIA.”
It is sometimes difficult to tell whether foreign anti-competitive conduct has a “direct, substantial and reasonably foreseeable effect” on U.S. markets. The Third Circuit has described the FTAIA as being “inelegantly phrased” and using “rather convoluted language.” A full discussion of the FTAIA must await a future article. However, this gray area should not obscure the fact that the Sherman Act clearly applies when a company, foreign or domestic, sells directly to U.S. customers at prices that have been fixed or rigged. There is no need to be paranoid and believe every vendor is colluding and fixing prices. But buyers should be alert, as they are often in the best position to see suspicious activity that may indicate collusion. •