Wednesday, 24 August 2011

Sims in the hot seat with the Foxtel / Austar merger following Metcash loss


Introduction
The ACCC’s recent Statement of Issues concerning the proposed merger between Foxtel and Austar was met with a great deal of consternation. The most strident criticism of the ACCC’s analysis came from Foxtel chief, Kim Williams, who labelled the ACCC decision as lacking any evidentiary basis and an example of “extravagant technology romanticism.”

In many respects, the criticism of the ACCC’s Statement of Issues was quite puzzling when one appreciates that it was entirely consistent with the ACCC’s published policy for the assessment of mergers, as set out in the Merger Guidelines. Accordingly, the ACCC’s views could not have come as a surprise to Foxtel, given that it must be familiar with the ACCC’s analytical approach to defining markets and analysing the competitive effect of mergers.

One is left wondering whether Foxtel’s strident criticisms of the ACCC Statement of Issues may have been motivated less by genuine puzzlement by the ACCC’s decision and more by a desire by Foxtel to pressure the new Chairman of the ACCC, Mr Rod Sims, into allowing the proposed merger to proceed.

There is no doubt that Sims will now be under even greater pressure to let the Foxtel – Austar merger through after the ACCC’s apparently comprehensive defeat in the Metcash case.

ACCC’s decision
The ACCC defined a number of separate markets in its Statement of Issues:
  • the national market for the supply of subscription television services to consumers; 
  • the national market for the acquisition of audio visual content; 
  • the national market for the supply of advertising opportunities to advertisers; and 
  • various telecommunications markets. 
The most controversial market defined by the ACCC was the national market for the supply of subscription television services to consumers. In relation to this market, the ACCC stated:

The ACCC’s preliminary view is that there is a national market for the supply of subscription television services to consumers. Other sources of supply of audio visual content to consumers, including FTA (Free to Air) television, mobile TV and internet content, are not sufficiently close substitutes to be considered in the same market.[1]

While the ACCC acknowledged that FTA operators compete to some extent with subscription television providers for the supply of audio visual content to consumers, in its view this has not developed to an extent where they could be considered to be close substitutes.

The ACCC’s statement appears to be a reference to actions by FTA providers to sell content to consumers through such relatively new technology as mobile TV, YouTube and Apple TC/iTunes.

Accordingly, the ACCC concluded that FTA would not act as a constraint on the pricing decisions of subscription television providers such as Foxtel and Austar.

In relation to the market for the acquisition of audio visual content, the ACCC largely accepted that there was close competition between FTA providers and subscription television providers. For example, FTA providers provided strong competition in relation to the acquisition of individual entertainment programs and sporting rights.

However, the ACCC noted that there were noticeable variations in the level of competition between FTA and subscription television providers depending on the types of audio visual content.

The ACCC also appears to have accepted that FTA television advertising is likely to be a sufficiently close substitute to subscription television advertising.

ACCC Concerns
The ACCC identified a number of issues of concern about the proposed Foxtel Austar merger.

The ACCC stated the preliminary view that the proposed acquisition was likely to substantially lessen competition in the national market for the supply of subscription television services. This conclusion was based on:
  • the narrow market definition which excluded FTA providers from the market and 
  • the belief that Foxtel and Austar would have the ability and incentive to compete directly following the rollout of the NBN.
In relation to the latter point, the ACCC stated:
As a result of programming arrangements entered into in the 1990s, agreements between FOXTEL, Austar and various content providers in effect currently divide the national subscription television market into two significant market segments; the metropolitan regions which are serviced by FOXTEL, and regional and rural Australia which is serviced by Austar. Further, the costs of expansion associated with distribution via traditional distribution platforms may have acted to maintain this geographic division. However, with the technological changes expected in the industry in the near future, it appears that FOXTEL or Austar (or both) will have the ability and incentive to expand beyond their current geographic footprints in the foreseeable future.
In other words, the ACCC believed that historical factors had lead to the market for the supply of subscription television services being segmented with Foxtel operating in the metropolitan areas and Austar operating in the regional areas.

The ACCC also believed that this historical and quite artificial lack of competition between Foxtel and Austar in geographic terms was likely to end with the roll out of the NBN. As stated by the ACCC:

To date, Foxtel and Austar have focused on growing their businesses in their existing geographic footprints as subscribers have continued to take up subscription television services. Over time, the incentives for FOXTEL and Austar to look to new opportunities for business growth, which may include geographic expansion of their existing operations, are likely to increase.

Expressed another way, the ACCC believed that both Foxtel and Austar had not sought to enter the other’s geographic territories in the past because they were more focused on winning customers within their existing geographic territories.

The ACCC concluded that there was unlikely to be any constraint on the merged firm from alternative subscription television providers and also that there was unlikely to be any new entry to the market for the provision of the subscription television services due to the high barriers to entry.

Foxtel response to ACCC decision

Following the ACCC’s Statement of Issues, various newspapers reported that Foxtel was contemplating legal action in the event that the ACCC blocked its proposed merger with Austar.

In particular, Mr Kim Williams, the CEO of Foxtel, was quite strident in his criticism of the ACCC decision. He is reported to have said that the ACCC decision was short on fact and full of bald assertions:
While the ACCC has raised some high-level issues, it provides limited evidence to back up some of its assertions. On this basis we believe Foxtel/Austar would be well positioned to have some success should it ultimately choose to take the ACCC to court, although we would still see a negotiated outcome as preferable for all parties and is therefore still more likely.[2]
Mr Williams was also quoted as saying:
What we have in the commission's statement of issue is a recital of opinions which do not have recourse to any kind of evidence. Parts of the commission are entitled to have their own personal opinions, but fortunately our legal system doesn't operate that way.

The commission seems to be suggesting in its paper – to test market views I must emphasise – that anything but Foxtel is a satisfactory conclusion. Frankly that is not good enough.
The ACCC seems to ignore the technological change that is enabling a host of well-capitalised new entrants to come into the TV market, for example, Apple, Google and Facebook.
What would appear to be evident in the commission’s paper is extravagant technology romanticism with an absence of evidentiary fact.[3]
In particular, Foxtel appeared most concerned about the ACCC’s conclusions that it did not consider subscription television and FTA television to be in the same market and that the proposed merger would eliminate potential competition between Foxtel and Austar. In this regard, Mr Williams said:
We believe that some of the ACCC arguments would be difficult to defend in court. For example, the view that pay TV and FTA don’t really compete and Foxtel and Austar would move into each other’s markets under the NBN.
Mr Williams’ claimed that the suggestion that Foxtel and Austar may become direct competitors in the future would be “an act of economic folly”.

Validity of Foxtel’s criticisms
Foxtel’s criticisms of the ACCC’s decision have little merit. The ACCC has not gone off on a tangent in its analysis but rather it has applied its published Merger Guidelines faithfully and correctly.

The ACCC’s approach to assessing mergers is clearly set out in its Merger Guidelines.

The first step in the analysis of a merger is to define the relevant market. This commences with a consideration of the level of overlap between the parties to the proposed merger:
The ACCC’s starting point for delineating relevant markets to assess a merger under s. 50 of the Act is identifying the products and geographic regions actually or potentially supplied by the merger parties. The ACCC then focuses on defining markets in areas of activity where competitive harm could occur. This must be assessed on a case-by-case basis. Generally, the ACCC focuses on overlaps between the products or geographic regions supplied by the merger parties, or some other meaningful economic relationship—such as an actual or potential vertical relationship or where the products supplied by the merger parties are complementary in nature. It is not uncommon for more than one market to be identified in any particular merger review.[4]
In other words, the first step in defining the market in the Foxtel and Austar merger would be to identify the overlap in the products and services which Foxtel and Austar sell or acquire in the market – namely subscription television services, audio visual content and advertising space.

The next stage is to consider whether the dimensions of this initial market should be expanded in product, geographic or functional terms to include close substitutes.

The ACCC then considers what other products and geographic regions, if any, constitute relevant close substitutes in defining the market. Importantly, the ACCC defines markets by reference to products and regions not by reference to the firms actually supplying those products or regions at the time of the merger.

The ACCC has to work out whether there are other products which are close substitutes to the goods or services being supplied by the merger parties. This may include goods or services which a customer may switch to if given sufficient price incentives.

In practical terms, the way this operates is to effectively dilute the market share of the merger parties in the market.

For example, if the market was limited to the services provided by the merger parties their market share would be 100% and they would be a monopoly. However, if a supplier in another state with the same total output as the merged firm was able to offer a competitively price substitute product, they would be included in the relevant market. This would have the effect of diluting the merged firm’s market share from 100% to 50% once the other firm’s sales had been included in the market.

This approach to market definition is based on the application of two tests – the Hypothetical Monopolist Test and the SSNIP test (also known as the price elevation test). The ACCC explains the application of these tests in its Merger Guidelines as follows:
The HMT determines the smallest area in product and geographic space within which a hypothetical current and future profit-maximising monopolist could effectively exercise market power. In general, the exercise of market power by the hypothetical monopolist is characterised by the imposition of a small but significant and non-transitory increase in price (SSNIP) above the price level that would prevail without the merger, assuming the terms of sale of all other products are held constant.
The process of applying the HMT starts with one of the products and geographic areas supplied by one or both of the merger parties. If a hypothetical monopolist supplier of this product cannot profitably institute a SSNIP because of customers switching to alternative products, the next closest demand substitute is added. If a hypothetical monopolist supplier of this extended group of products cannot profitably institute such a price increase because of customers switching to alternative products, the next best substitute is added. The collection of products is expanded until a hypothetical monopoly supplier of all those products could profitably institute a SSNIP.
A SSNIP in the context of the HMT usually consists of a price rise for the foreseeable future of at least 5 per cent above the price level that would prevail without the merger.
While the HMT is a useful tool for analysis, it is rarely strictly applied to factual circumstances in a merger review because of its onerous data requirement. Consequently, the ACCC will generally take a qualitative approach to market definition, using the HMT as an ‘intellectual aid to focus the exercise’.
This means that the ACCC will assume that the merged firm is in fact a monopolist (which makes sense given that it is only their sales which have been included in the market in the first step of the market definition process) and then apply the SSNIP test.

The SSNIP test involves the ACCC asking the question whether customers of the merger parties would switch to another product or source of supply in response to a small non-transitory increase in price by the hypothetical monopolist. This test is used to work out what products and sources of supply are close substitutes.

In the present case, the ACCC would have had to ask itself how existing customers of a hypothetical merged Foxtel and Austar company would react if the merged firm put up its prices by 5%. For example, would existing customers of Foxtel and Austar switch to another product or source of supply if the price of say the Family Package went up from $75 per month to $79.90 per month.

It is quite apparent that when one asks this specific question the conclusion has to be that subscription television services and FTA television services are in separate markets. It would not make any sense for an existing customer who is currently paying $75 per month for a Family Package to suddenly decide to cancel their subscription and switch to FTA in response to a $3.90 price rise. This consumer has already made a decision that the services they are receiving from Foxtel for $75 per month are worthwhile and superior to FTA television.

This is not to say FTA will not have some impact on the purchasing decisions of prospective consumers. There are likely to be many consumers who were previously considering whether to purchase a subscription television service, who will now decide against making that decision due to the relatively recent expansion of FTA channels.

However, do the decisions of these consumers not to buy a subscription television service because of the improved range of FTA channels constrain Foxtel or Austar’s pricing decisions in any meaningful way?

The answer is clearly no. Foxtel and Austar will retain considerable pricing discretion in relation to its existing customers because these customers are highly unlikely to switch to FTA television in response to a SSNIP.

The Hypothetical Monopolist Test and the SSNIP test are not novel or unique tests. Rather, these tests are applied by virtually every leading merger regulator in the world. These tests are also generally accepted analytical methods to defining the relevant market.

Foxtel’s other major criticism of the ACCC’s decision relates to the ACCC’s conclusion that Foxtel and Austar are likely move into each other’s markets under the NBN. Foxtel disputed the ACCC’s conclusion that Foxtel and Austar were likely become head-to-head competitors in the market once the NBN has been established.

The ACCC makes it very clear in its Merger Guidelines that it considers supply-side substitution in defining the relevant market. This means that the ACCC will look at the ability of other suppliers to, either, start manufacturing the same goods or services as the merged firm by diversifying, or commence the supply of the same goods or services as the merged firm from a more distant geographic location. The first type of supply-side substitution depends largely on whether the other firm’s manufacturing plant or distribution system can be adjusted quickly and relatively cheaply to provide the relevant product or service at a competitive price. The second type of supply side substitution depends primarily on freight differentials.

It is not clear whether Foxtel submitted to the ACCC that Foxtel and Austar are not in fact competitors because they operate in different geographic markets in the supply of subscription television services.

However, the fact that Foxtel and Austar compete head-to-head in the Gold Coast area undermines any claim that Foxtel may have made that they are in a different geographic market to Austar. The fact that Foxtel and Austar compete in Gold Coast proves that such head-to-head competition is clearly possible.

It seems, from the limited public information which is available that Foxtel must have accepted that Foxtel and Austar are in the same geographic market for the supply of subscription television services, but that there were economically rational reasons for the companies not to compete.

This argument must have been presented to the ACCC in terms of merger factor (f) which requires the ACCC to consider the availability of substitutes in the market – section 50(3)(f)

Section 50(3)(f) is probably the least well understood merger factor. Often it is presented to the ACCC in merger submissions as simply a rehash of market definition. However, this is not the correct approach to section 50(3)(f).

As stated above, the first step in the merger review process is to define the relevant market. Once this process has been completed, the ACCC will then prepare a market share table which shows all the competitors in the market and their respective market shares. For example:

National market for
the supply of Product X

Company A 40% market share

Company B 20% market share

Company C 20% market share

Company D 10% market share

Company E 10% market share


If Company A and Company B are proposing to merge, then it would be important for the ACCC to assess the likely competitive responses of each of the remaining competitors in the market. The ACCC would have to determine whether the remaining competitors would be willing and/or able to compete with the merger firm or whether they would become price followers?

For example, if Company C is a new start up company which has proven to be highly innovative and aggressive in the market, it may be able to constrain the pricing decisions of the merged firm.

On the other hand, if Company C and D both have no excess capacity in their manufacturing plants, they may be unable to respond to prices increases by the merged firm by increasing their output.

This qualitative consideration of the relative strengths and weaknesses of the competitors in the market who provide close substitutes has to occur somewhere in the ACCC’s analysis. The appropriate place for this analysis to take place is in the ACCC consideration of merger factor (f).

Therefore, in the Foxtel - Austar matter it would appear that Foxtel accepted that Foxtel and Austar were in the same market, but then argued that they would not exercise a competitive restraint on each other’s pricing decisions for other reasons under the section 50(3)(f) merger factor.

There were some media reports that indicated that the merger parties had put the following argument to the ACCC. Namely, that Foxtel and Austar would not constrain each others pricing decisions because it would cost each of them more money to pursue customers in the other’s geographic territory than it would to keep focusing their efforts on trying to gain new customers in their existing geographic territory

In other words, Foxtel submitted to the ACCC that it would not make any sense for Foxtel to try to win an existing customer from Austar in a regional area, because they would be able to make a bigger margin by gaining a new customer in a metropolitan area.

These submissions are tantamount to Foxtel saying because it can generate a margin of say 20% from a metropolitan customer and only 5% from winning an Austar customer, it would be “economic folly” for it not to focus exclusively on winning new metropolitan customers.

Unfortunately, this argument makes absolutely no economic sense, particularly in relation to subscription television services. In a competitive market, companies will generally try to win customers from anywhere and from anybody as long that one additional customer is profitable for the company.

While there may be some rare situations where companies may not seek to win low margin customers, this is usually where the costs of winning a new customer are very high. A good example of this situation is in relation to large construction contracts where the costs of preparing a tender can be very significant.

However, the marketing costs incurred in trying to win new subscription television customers do not appear to be significant. Indeed, it seems that the primary marketing technique used by Foxtel to win new customers is to undertake regular letterbox drops of written advertising materials, which is hardly a high cost marketing technique.

Accordingly, the ACCC would be right to reject Foxtel’s argument as to why Foxtel and Austar currently do not try to compete more vigorously against each other in more geographic areas than simply the Gold Coast.

Whilst there may be other reasons why Foxtel and Austar do not compete head-to-head in every market in Australia with the exception of the Gold Coast and apparently, have no interest in competing head-to-head in these markets in the future, these reasons do not appear to be based on any rational economic theory.

Decision time for Rod Sims

Given the extreme nature of Foxtel’s comments about the ACCC’s decision, one could be forgiven for believing that the ACCC had applied novel and untried economic theories to its consideration of the Foxtel – Austar merger. However, this belief would be mistaken.

The reality is that the ACCC has faithfully and transparently applied the methodological framework outlined in its Merger Guidelines to the Foxtel - Austar merger and reached a number of quite predictable and analytically correct conclusions. The methodological framework outlined in the Merger Guidelines (which incidentally were first issued by the ACCC in 1999, over 10 years ago) are based on widely accepted economic principles that are utilised by virtually every other leading overseas merger regulator.

Therefore, questions arise as to:
  • why was Foxtel apparently so surprised by the ACCC’s preliminary views? 
  • why was such a large and sophisticated company such as Foxtel so puzzled by the ACCC’s findings about the merger given that these findings were quite predictable for anyone with even a cursory understanding of the ACCC’s approach to merger analysis and its published Merger Guidelines? 
  • why was Foxtel so surprised that FTA television services were not included in the market for subscription television services given that it must have know the way that the SSNIP test is applied by the ACCC to determine the existence of close substitutes?
It is highly unlikely that Foxtel has been poorly advised in relation to the ACCC issues which were likely to arise in relation to the Foxtel – Austar proposed merger. Accordingly, there must be another explanation for Foxtel’s extreme position.

Is it the case that Foxtel’s comments may have been driven by strategic considerations?

It is well known that the Statement of Issues issued by the ACCC on 22 July 2011 was one of the last major decisions made by Graeme Samuel during his reign as ACCC Chairman. In fact, some commentators were very surprised that Mr Samuel went ahead and made such a significant decision so close to the end of his appointment given he would not be around to finalise the decision.

Indeed, many commentators expected Samuel to postpone the Statement of Issues in relation to the Foxtel - Austar merger so that it could be considered by the new ACCC Chairman, Mr Rod Sims, once he had taken up his new role.

However, now the responsibility of making a final decision on the Foxtel – Austar merger rests squarely on Rod Sims. Indeed, this is likely to be his first major merger decision during his term as the Chairman of the ACCC.

Accordingly, there may be some grounds for suspecting that Foxtel’s strident criticisms of the ACCC’s decision may have been made for the strategic purpose of trying to put maximum pressure on Rod Sims to let the deal through.

Foxtel may have come to the conclusion that Rod Sims will not want to start his role at the ACCC by embarking on major litigation against the combined might of Foxtel and Austar and their main financial backers, who include News Limited, Telstra and Consolidated Media Holdings.

Unfortunately, it now seems that Rod Sims is in the position of either standing by the ACCC’s previous Statement of Issues and opposing the Foxtel – Austar merger or abandoning the Statement of Issues and letting the merger through.

If Rod Sims opposes the Foxtel – Austar merger it is likely that litigation will ensue. This litigation is likely to be both very expensive and time consuming for the ACCC. Indeed, it would have the potential to bankrupt the ACCC, particularly when one factors in the enormous legal bill that the ACCC will be receiving from Metcash and Franklins unless it can overturn Justice Emmett’s decision to dismiss the ACCC’s case seeking to prevent that merger.

On the other hand, if Rod Sims lets the merger through it may appear that he has caved in to pressure from Foxtel. Such a perception would not auger well for his future role as the Chairman of the ACCC.

Unfortunately, for Rod Sims there does not appear to be a simple third option such as accepting the divestment of strategic assets in order to mitigate the potential anti-competitive effects of the proposed merger.

The only possible alternative for the ACCC may be to let the deal through with some form of behavioural undertaking from the merged firm. For example, a behavioural undertaking from the merged firm that they agree to make particular content available to fledgling providers of content on reasonable terms for a defined period of time may be the solution.

However, one thing is clear. It would have made Mr Sims’ initiation to the role of ACCC Chairman a great deal easier if the former ACCC Chairman of the ACCC had simply deferred the preliminary decision on the Foxtel Austar merger until after Rod Sims had taken over.

Sims’ decision has now been made a great deal harder in the light of the ACCC’s apparently comprehensive loss in the Metcash case which will no doubt raise significant questions over the ACCC’s methodology and approach to merger analysis .



[1] Statement of Issues – Foxtel – proposed acquisition of Austar United Communications Limited, dated 22 July 2011 - http://www.accc.gov.au/content/index.phtml/itemId/975742
[2] “Foxtel eyes legal action against ACCC if Austar acquisition is determined anticompetitive”, The Australian, 25 July 2011.
[3] “ACCC delivers hammer blow to Foxtel’s bid”, The Australian, 23 July 2011.
[4] ACCC Merger Guidelines, 2008 - http://www.accc.gov.au/content/index.phtml/itemId/809866

Sunday, 7 August 2011

ACCC and the Max Brenner Boycotts


Introduction
Recently, Mr Michael O’Brien, the Victorian Minister of Consumer Affairs, stated that the actions of various anti-Israel activists in boycotting Max Brenner stores is likely to be illegal. Mr O’Brien has also called on the ACCC to take urgent legal action against the persons engaged in the boycotts.[1]

Mr O’Brien is correct in his assessment that the alleged boycotts are likely to constitute a contravention of section 45D of the Competition and Consumer Act 2010 (CCA) (formerly the Trade Practices Act 1974). Furthermore, he is right to call on the ACCC to take immediate action to prevent the boycotts continuing.

Unfortunately, the ACCC has been quite inactive in the enforcement of the secondary boycott provisions of the CCA for many years. The last cases which the ACCC took under these provisions were settled in late 2006. Whether this inactivity in relation to secondary boycotts is due to the absence of appropriate cases or due to a lack of political will by the ACCC due to the election of the Federal Labor government in 2007, is unclear.

However, the ACCC should immediately commence an investigation into the apparently blatant illegal boycotts of Max Brenner stores.

Relevant legislation
Boycotts are prohibited under Part IV of the CCA. The relevant provision in relation to the alleged boycotts of Max Brenner stores is section 45D.

Section 45D prohibits two types of conduct – a supply boycott and an acquisition boycott.

A supply boycott under section 45D(1)(a)(i) arises where two persons act in concert to prevent a third person from supplying goods or services to a fourth person.

In the case of the boycotts of Max Brenner stores, this provision would operate as follows:
  • two persons have acted in concert to prevent
  • a third person (ie Max Brenner) from supplying goods and services to;
  • a fourth person (ie Max Brenner customers). 
While the alleged conduct in relation to Max Brenner appears to satisfy section 45D(1)(a)(i), the complication arises with the application of subsection 45D(1)(b). This subsection states that in order for section 45D to apply, the conduct must have the purpose and effect of causing the fourth person substantial loss or damage.

In the present case, the purpose of the boycott is unlikely to be aimed at causing loss or damage to Max Brenner’s customers - rather its purpose would appear to be to cause loss and damage to Max Brenner’s business.

Having said that, it is likely the acquisition formulation under section 45D applies to the Max Brenner boycotts.

An acquisition boycott arises under section 45D(1)(a)(ii) where two persons act in concert to prevent a third person from acquiring goods or services from a fourth person.

In the present case, this provision would operates as follows:
  • two persons have acted in concert to prevent;
  • a third person (ie Max Brenner customers) from acquiring goods and services from;
  • a fourth person (ie Max Brenner). 
This formulation also satisfies the requirements of second part of section 45D, as it is likely that the purpose and effect of the boycott is to cause substantial loss and damage to the business of the fourth person - ie Max Brenner.

Defences
There are a number of defences to a breach of section 45D. However, it is unlikely that any of these defences apply to the boycotts of Max Brenner stores.

First, it is a defence if a person’s conduct in engaging in a boycott is substantially related to the remuneration, conditions of employment, hours of work or working conditions of that person or of another person employed by an employer of that person. There is no suggestion that the boycotts of Max Brenner stores are related to the working conditions of any relevant persons.

Second, it is a defence to section 45D if the dominant purpose of a person’s conduct is substantially related to environmental protection or consumer protection. This is also clearly not the case in relation to the Max Brenner boycotts.

Finally, there is no defence in the CCA to liability for an illegal boycott on the ground that the person is engaged in a political protest.

Issues in secondary boycott cases
The main issues which the ACCC has to pay particular attention to in conducting an investigation into the alleged breaches of section 45D by the anti-Israel protestors are:
  • how to establish the identities of the persons involved in the boycott;
  • the requirement to prove both effect and purpose; and
  • how to establish purpose.
As strange as this sounds, it often very difficult in boycott cases to establish the actual identities of the persons involved. This is because the parties involved are often briefed not to disclose their identity to any authorities, particularly the ACCC. It is a very rare occurrence for individuals involved in a boycott to identify themselves by say, holding up a placard stating the name of their organisation or by wearing identity badges.

Accordingly, in the past the ACCC has often had to rely on visual identification of the individuals involved in the boycott to establish their case. This approach will only work if the persons engaging in the boycott are known by sight to other persons assisting the ACCC and then only if these persons are willing to provide evidence for use in legal proceedings.

Unfortunately, in the case of the Max Brenner boycotts it is very unlikely that the individuals involved will be known to either the ACCC or Max Brenner.

The main reason why it is important to know the identities of the individuals involved in the boycott is because of the availability of pecuniary penalties. Pecuniary penalties of $750,000 per contravention are only available for a breach of section 45D by a body corporate - section 76(1A)(a). However, there are no pecuniary penalties available against an individuals for engaging in a boycott – section 76(2).

Therefore, in order to obtain a pecuniary penalty the ACCC will have to prove that the boycotts were engaged in by a body corporate. The ACCC can do this one of two ways.

First, the ACCC can seek to obtain admissions from officers of the body corporate of the involvement of the body corporate in the boycott either orally or from the organisation’s documents. For example, in the present case, the ACCC should be trying to identify public statements by organisations either admitting their involvement in the boycotts or inducing others to engage in the boycotts. For example, the media release issued by the Communist Part of Australia entitled CPA Statement on Israeli Boycotts, dated 30 March 2011, may constitute an example of an organisation inducing others to breach section 45D.[2]

Alternatively, the ACCC can establish the liability of a body corporate by utilising section 45DC. Under this provision, if it can be established that two or more of the persons involved in a boycott are members or officers of the same employee organisation, then that employee organisation will be deemed to have engaged in the boycott unless they can prove otherwise.

In other words, if it can be proved that two of the persons who engaged in a Max Brenner boycott were members of, say, the Maritime Union of Australia (MUA), then the MUA could be held legally liable for the boycott. This liability would be subject to the MUA being able to prove that the relevant employees were acting independently and without the authority of the MUA.

However, if two of the persons engaging in a boycott were members of a political party, for example the Greens, section 45DC would not apply. This is because the section only deems employee organisations to be liable under section 45D for the acts of their members.

The second complication relates to the requirement under section 45D that the ACCC prove both purpose and effect. Many other provisions of the CCA, such as sections 45 and 47, require the ACCC to prove either purpose or effect. However, section 45D requires the ACCC to prove both purpose and effect.

In practical terms, this means that the ACCC will have to prove that the persons engaging in the boycotts had the purpose of causing Max Brenner’s business substantial loss or damage and also that the boycott had or was likely to have the effect of causing Max Brenner’s business substantial loss or damage.

The final issue to note relates to the special rules which relate to proving purpose under section 45D. Subsection 45(2) of the CCA states:
(2) A person is taken to engage in conduct for a purpose mentioned in subsection (1) if the person engages in the conduct for purposes that include that purpose.
The usual rule under the CCA, as embodied in section 4F, is that a party can only be held liable for a purpose which is considered to be a substantial purpose. However, the effect of section 45D is to make a party liable for simply having a purpose of causing substantial loss and damage, irrespective of how significant or substantial that purpose is compared with all other purposes.

Therefore, if the anti-Israel protestors claimed that the overriding purpose of their boycott was to protest Israeli government policies, and that causing Max Brenner substantial loss and damage was only a secondary and insignificant purpose, this admission would be sufficient to establish the purpose requirement under section 45D.

Conclusion
Despite the ACCC’s apparent unwillingness to enforce the secondary boycott provisions of the CCA over the last five years under the Chairmanship of Graeme Samuel , it is appropriate for the ACCC to heed the calls from Mr O’Brien and intervene in the Max Brenner boycotts. The recent boycotts by the anti-Israeli protestors appear to constitute a blatant breaches of the secondary boycott provisions of the CCA.

Furthermore, inaction by the ACCC on this issue could very well encourage other activist groups to engage in similar boycotts against other businesses who are associated with countries whose policies they do not like. This may lead, in turn, to other private retail businesses suffered substantial loss and damage at a time when they can ill afford such illegal disruptions to their businesses.

Whatever ones political beliefs in relation to the Israeli Government’s policies may be, it is essential that all groups in our society respect and abide by the rule of law. If any groups choose to ignore or flaunt the rule of law, they must be forced to abide by such laws by law enforcement agencies such as the ACCC.


[1] Media Release entitled “Coalition Govt asks ACCC to probe movement for BDS anti-Israeli secondary boycott”, dated 8 August 2011 - http://vic.liberal.org.au/News/MediaReleases/tabid/159/articleType/ArticleView/articleId/3687/Coalition-Govt-asks-ACCC-to-probe-BDS-movement-for-anti-Israeli-secondary-boycott.aspx
[2] See http://www.cpa.org.au/guardian/2011/1495/03-cpa-statement-israel.html.






Thursday, 4 August 2011

Monsters Inc - No Headhunting Allowed


Introduction
Recently, the US Department of Justice settled two antitrust investigations into illegal anticompetitive agreements amongst seven high profile technology companies.[1] Given the identities of the companies involved and the serious illegality involved, it is highly surprising that the settlement went through without a great deal of publicity. Indeed, it is probably even more surprising that the DOJ decided to commence civil litigation in the first place, rather than criminal prosecutions, given the conduct involved six separate naked restraints in breach of section 1 of the Sherman Act by such corporate giants as Google, Apple, Intel, Adobe and Lucasfilm.

Unfortunately, it appears that the DOJ has failed in its mandate by not pursuing the companies involved in these illegal agreements more vigorously. The conduct merited more serious sanctions than simply a promise not to engage in such conduct again in the future. The DOJ should have taken criminal prosecutions against the companies involved given the seriousness of the conduct. Ultimately, it may have been a case of the DOJ being simply too fearful of commencing criminal proceedings against these corporate behemoths because of their combined legal and financial firepower.

Background
In September 2010, the DOJ commenced legal action against Google, Apple, Adobe, Intel, Pixar and Intuit for alleged contraventions of section 1 of the Sherman Act.[2] On December 2010, the DOJ instituted separate legal proceedings against Lucasfilm for similar conduct.[3]

Google, Apple, Adobe, Intel, Pixar and Intuit case (Google case)
The DOJ alleged in its case that Google, Apple, Adobe, Intel, Pixar and Intuit had contravened section 1 of the Sherman Act by entering into a number of agreements preventing them from cold calling employees of the other companies with employment offers.

Section 1 of the Sherman Act prohibits:
Every contract, combination in the form or a trust or otherwise, in restraint of trade or commerce among the several states.
The DOJ found that the companies had entered into five separate agreements as follows: 
  • Apple – Google 
  • Apple – Adobe 
  • Apple – Pixar 
  • Google – Intel 
  • Google – Intuit. 
These agreements had a number of common characteristics.

First, each of the agreements instructed all employees not to actively solicit staff from the other party to the agreement.

Second, all of the agreements had been in existence for a number of years. The Apple – Adobe agreement commenced in 2005 while the Apple – Google agreement commenced in 2006. All of the remaining agreements (ie Apple – Pixar, Google – Intel and Google – Intuit) commenced in 2007.

Third, the agreements were designed and entered into by senior executives of each of the companies.

Fourth, these senior executives actively managed and enforced the agreements through direct communications with the other companies.

Fifth, the agreements covered all employees of the firms. The agreements were not limited by geography, job function, product group or time period.

Finally, each company maintained a written “Do Not Call List” which each of the companies displayed prominently in their premises. These lists included the names of the company or companies which the employees were not permitted to cold call pursuant to the agreements.

The DOJ found in relation to the Apple – Google agreement, there had been a number of instances of Apple complaining to Google about alleged breaches of the agreement. As a result of receiving these complaints, Google conducted a number of internal investigations to determine whether there had in fact been a breach of the agreement. Once these internal investigations were completed, Google reported its findings back to Apple.

Similarly, there was evidence that Intuit had complained to Google about breaches of their agreement. Google responded by conducting an internal investigations into these complaints to determine whether there had been a breach of the agreement.

The DOJ also found that Adobe had only agreed to enter into the agreement with Apple because if feared that if it refused, Apple would retaliate by headhunting a large number of its employees.

Competitive Impact Statement[4]
The DOJ discussed the likely competitive impact of the illegal conduct in its Competitive Impact Statement (CIS) which was filed in support of the final settlement.

In the CIS, the DOJ stated that:
The effect of these agreements was to reduce Defendant’s competition for highly skilled technical employees (high tech employees), diminish potential employment opportunities for those same employees and interfere with the proper functioning of the price-setting mechanism that would otherwise have prevailed.
The DOJ concluded that the agreements were naked restraints of trade in violation of Section 1 of the Sherman Act.

Antitrust laws in the United States draw a distinction between naked restraints and ancillary restraints.

If a restraint is broader than is reasonably necessary to achieve efficiencies from a business collaboration, they are defined as a naked restraint which is per se unlawful. Naked restraints are prohibited on a per se basis because of their pernicious effect on competition and their lack of any redeeming virtues.

On the other hand, ancillary restraints are not per se illegal. In order to be characterised as an ancillary restraint, an agreement must be ancillary to a legitimate pro-competitive venture and reasonably necessary to achieve that pro-competitive benefit. If a restraint is determined to be an ancillary restraint it will be then be evaluated under the rule of reason test. This test balances the pro-competitive benefits of the restraint against its anticompetitive effects.

The DOJ noted in the CIS that whilst the various defendants had been engaged in a number or legitimate collaborative projects, the employment agreements were not ancillary to those projects. Indeed the illegal agreements did not specifically refer to any collaborative projects at all – rather the agreements applied to all company employees and were not limited by geography, job function, product group or time period.

Agreed Settlement[5]
The agreed settlement had four main elements:
  • Prohibited conduct. 
  • Conduct not prohibited. 
  • Required Conduct. 
  • Compliance. 
Prohibited conduct
Under the final judgment, the defendants were prohibited from agreeing, or attempting to agree, with another person to refrain from cold calling, soliciting, recruiting or otherwise competing for the employees of another person.

The defendants were also prohibited from requesting or pressuring another person to refrain from such competitive conduct.

The orders went beyond the conduct which formed the basis of the initial complaint. While the agreements had only related to cold calling employees from the other company, the orders prohibit restrictions on cold calling as well as restrictions on all forms of solicitation and recruitment.

Conduct Not Prohibited
This section outlines the conduct which is not prohibited by the final judgment. The prohibition will not apply to “no direct” solicitation provisions which are:
  • contained in existing and future employment or severance agreements; 
  • reasonably necessary for mergers or acquisitions (consummated or unconsummated), investments or divestitures, including due diligence; 
  • reasonably necessary for contracts with consultants or recipients of consulting services, auditors, outsourcing vendors, recruiting agencies or providers of temporary employees or contract worked; 
  • reasonably necessary for the settlement or compromise of legal disputes; and 
  • reasonably necessary for contracts with resellers or OEM’s, providers or recipients of services, and the function of legitimate collaborative agreements. 
The effect of this section of the final judgement is to carve out a quite large area of business activity where the companies will still be permitted to impose restrictions on the free movement of employees. However, this section does not allow the companies to enter into collective agreements to prevent competition amongst them for employees.

Required Conduct
The final judgement establishes mandatory procedures for ensuring the defendant’s compliance with the final judgment.

The defendant’s main obligation is to ensure that each relevant officer of the company is made aware of the details of the final judgment. The defendants are to do this by providing staff with a copy of the final judgement and annual briefings to explain the meaning and requirements of the final judgment.

The defendants must provide the DOJ with certification that they have complied with their obligations to educate their employees about the final judgment. The defendants must also maintain a written record of any violations of the terms of the final judgment.

Compliance
The final judgment confers a number of rights on the DOJ so that it can effectively monitor the defendant’s compliance with the final judgment. For example, the DOJ is permitted access to all of the defendant’s records. It also has access to the defendant’s employees for the purposes of conducting interviews and taking depositions.

Lucasfilm - Pixar agreement
The Lucasfilm and Pixar agreement and settlement is quite similar to the Google matter described above. However there was one significant difference between the agreements – ie the Lucasfilm – Pixar agreement appears to have constituted an even more serious contravention of section 1 of the Sherman Act than the Google case agreements.

Lucasfilm and Pixar entered into a three-part agreement with the following restrictions:
  • not to cold call the other company’s digital animators to offer them employment, 
  • not to make counteroffers under certain circumstances to the other company’s digital animators; and 
  • to provide notification to the other company when they made an employment offer to a digital animator employed by the other company. As is apparent, this agreement was more specific than the Google case agreements and also contained more extensive restrictions.
This agreement was entered into by the companies in January 2005 and was actively policed by senior executives of each firm.

A number of complaints were made under the agreement that the other party was not honouring the terms of the agreement. These complaints were subsequently investigated and the parties then implemented steps to ensure future conformity with the agreement.

The DOJ concluded that the Lucasfilm - Pixar agreement had:
  • reduced the ability of the parties to compete for employees; 
  • disrupted the normal price setting mechanisms that apply in labour markets; 
  • eliminated significant forms of competition for digital animators; and  
  • substantially diminished competition to the detriment of the affected employees. As a result, digital animators were likely to have been deprived of competitively important information about job opportunities as well as being denied access to better job prospects.
Competitive Impact Statement[6]
The CIS in relation to this settlement is quite similar to the CIS in the Google case.

The main difference is that this CIS seeks to distinguish the case from the Google case in terms of its more serious effect on competition:
The restraint challenged here is broader than the no cold call restraints challenged in United States v Adobe Systems Inc. The prohibition on counteroffers by non-employing firms renders the Lucasfilm-Pixar agreement, taken as a whole, more pernicious than an agreement to refrain from cold calling and is per se illegal.
Settlement
The settlement in relation to the Lucasfilm – Pixar agreement is in all practical respects identical to the settlement in the Google case.

Commentary
In deciding what enforcement response to take in relation to anticompetitive conduct, an antitrust regulator will place considerable weight on the seriousness of the conduct. In particular, an antitrust regulator will seriously consider taking criminal proceedings (where such proceedings are available) in relation to per se offences (ie naked restraints). This likelihood is enhanced when the antitrust regulator believes that the agreements have had a significantly adverse effect on competition in a market. Despite making this clear finding in relation to both the Google case agreements and the Lucasfilm – Pixar agreement of significant adverse effects on competition, the DOJ decided to pursue a civil action.

Furthermore, by deciding to pursue a civil proceeding in these cases, the DOJ precluded itself from being able to seek a fine in relation to the agreements. In the US fines are only available in relation to criminal prosecutions and not civil proceedings.

Another important factor for an antitrust regulator to weigh up in deciding whether to commence criminal proceedings is whether the conduct has been occurring for a long period of time. An antitrust regulator may conclude that criminal proceedings are not appropriate where a cartel has only been in existence for only a short period, for example less than 12 months. However, in the present cases, all of the agreements had been in place for between four and six years, which is a significant period for companies to be engaged in an illegal cartel.

It should also have been highly relevant to the DOJ’s decision-making process that all of the agreements were designed, negotiated and implemented by senior executives of each of the companies. Furthermore, the agreements were all actively managed and enforced by these senior executives throughout the life of the agreements.

These agreements were not the handiwork of junior employees acting on a frolic of their own. Rather these agreements were properly seen as company policies to lessen competition devised at the most senior levels of each of the companies. The fact that senior executives were the authors of the agreements would generally be considered a significant aggravating factor by an antitrust regulator when determining the appropriate enforcement response. Indeed, it is usually the case that involvement by senior executives in a long running and detrimental cartel would result in the antitrust regulator deciding to commence criminal proceedings against both the company and senior executives involved in the conduct.

Finally, there would be no validity in a claim by the companies that there did not know that the conduct was illegal. The fact that employers are not permitted to enter into restrictive agreements preventing competition for employees is well established and well understood law in the US. It is well know that such agreements will constitute a contravention of section 1 of the Sherman Act.

As observed by the DOJ in both of the CIS's filed in these matters, similar types of restraints by employers in relation to employees have been challenged by the DOJ in the past.

In both of the CIS's the DOJ made reference to the case of United States v Ass’n of Family Practice Residency Doctors No. 96-575-CV-W-2, Complaint at 6 (W.D.Mo. May 28, 1996) which involved similar employment restraints as those the subject of the Google case.[7] In this case, the Association issued guidelines to its members which were designed to restrict competition for senior medical students between residency programs. In particular, the guidelines included a restraint preventing family practice residency program directors from directly soliciting family practice residents from other residencies.

The DOJ commenced civil legal proceedings against the Association for this conduct, alleging per se violations of Section 1 of the Sherman Act.

Accordingly, there can be no doubt that each of the companies must have been aware, based on the Family Practice Residency Doctors case and other relevant DOJ cases, that agreements between competitors not to compete for employees were illegal per se under section 1 of the Sherman Act.

In the context of the various factors discussed above, it is very surprising that the DOJ decided to take such a light-handed enforcement approach to these agreements. There is simply no credible reason, based on generally accepted antitrust enforcement criteria, for these agreements to be settled on a civil basis rather than the DOJ deciding to commence criminal prosecutions and seek significant fines.

Conclusion
The decision by the DOJ to settle these employment restriction cases on a civil basis is very puzzling.

One explanation for the DOJ’s approach may be that the agency has become quite lenient in its approach to the enforcement of section 1 of the Sherman Act where the conduct relates to restrictions on employees rather than restrictions on the supply of goods and services. If this were indeed the explanation for the DOJ’s approach in these cases, it would be a very unfortunate development. This is because such employer agreements will invariably cause the individual employees effected by such agreements considerable financial detriment in terms of lost income and lost opportunities.

Another possible explanation for the DOJ’s light-handed response to these agreements, may due to the agency being simply too fearful of the prospect of commencing criminal proceedings against such large companies because of their legal and financial firepower. There is no doubt that had the DOJ commenced criminal proceedings against Google, Apple, Intel, Adobe, Intuit, Lucasfilm and Pixar, the litigation would have been enormously expensive for the DOJ. However, antitrust regulators must not make "bad" enforcement decisions because they are concerned about the cost implications of taking large cases. If antitrust regulators are too risk adverse to take on such large cases, who will be left to pursue such cases?

Whatever the reason for the DOJ’s questionable approach to punishing these companies for their illegal agreements, it is clear the DOJ has lost the opportunity to pursue a landmark case which would have done a great deal to clarify the application of antitrust law to employment markets. Unfortunately, it is unlikely that the DOJ will get a another chance to run such an important case in this particular area in the future.


[1] The proposed settlement in the United States v Adobe Systems, Inc., Apple Inc., Google Inc., Intel Corporation, Intuit Inc., and Pixar was filed on 24 September 2010. Final Judgment was entered on 17 March 2011. The proposed settlement in United States v Lucasfilm was filed on 21 December 2010 and Final Judgment entered on 3 June 2011.
[2] Complaint - http://www.justice.gov/atr/cases/f262600/262654.htm
[3] Complaint - http://www.justice.gov/atr/cases/f265300/265395.htm
[4] CIS - http://www.justice.gov/atr/cases/f262600/262650.htm
[5] Final Judgment - http://www.justice.gov/atr/cases/f272300/272393.htm
[6] CIS - http://www.justice.gov/atr/cases/f265300/265397.htm
[7] CIS - http://www.justice.gov/atr/cases/f262600/262650.htm