UK: OFT Heavily Criticised For Its Approach To Penalties

Originally published 14 March 2011

Keywords: OFT, competition appeal tribunal, CAT, fines, construction cover pricing

The UK's Competition Appeal Tribunal ("CAT") has reduced to a fraction of the original amount the fines imposed by the UK Office of Fair Trading ("OFT") on six construction companies in the construction cover pricing case. The CAT's judgment, handed down on 11 March 2011, criticises the OFT's view of the seriousness of the infringements concerned and the OFT's "one size fits all" approach to adding a deterrence factor to the companies' basic fines.

The judgment will be a significant blow to the OFT, as it has reduced fines totalling £41.78 million to £4.4 million. It is likely to force the OFT to reconsider its approach to calculating penalties in future cases.

The six companies are among the 25 companies that appealed the OFT's September 2009 decision to impose heavy penalties on 103 construction companies it found had engaged in cover pricing between 2000 and 2004. Judgment in the remaining 19 appeals is still awaited.

The CAT's composite judgment upholds appeals by Kier, Ballast, Bowmer, Corringway, Thomas Vale and Sisk. Kier's original fine was the largest imposed by the OFT, at £17.9 million – this has been reduced by nearly 90%, to £1.7 million. The largest reduction, of 94.2%, was awarded to Sisk, whose £6.2 million fine - for one single infringement - the CAT has reduced to £356,250.

The key factors in the CAT's judgment, and their implications for the future, are as follows.

• The level of seriousness attributable to cover pricing was too high
  
  The OFT calculates the basic fine by applying a percentage figure to the infringer's turnover in the market affected by the infringement. This figure can be 0-10%, depending on the seriousness of the infringement. The CAT has commented that this range may be too narrow and has invited the OFT to reconsider it when revising its 2004 guidance on penalties.
  
  The CAT has reduced the OFT's 5% to 3.5%, for two main reasons:
  
  
  • The nature of cover pricing: Although cover pricing was not innocuous, it did not merit the severity of treatment meted out by the OFT. The intentions of parties engaged in cover pricing are not to increase the price the customer should pay (as with normal cartel-type conduct), but to identify a price that the customer is not willing to pay, so that the firm receiving the cover price can be sure not to win the contract (a decision it has already made). Given that any tenderer wanting to win the contract will put forward its keenest bid irrespective of cover pricing, the harm caused is likely to be small compared with a hardcore cartel.
  • Industry practices at the time of the infringements: During the period 2000 to 2004, when most of the infringements took place, the perception in the industry was that cover pricing was acceptable.
    
    
  Although it did not affect the outcome of the appeals, the CAT also criticises the OFT's narrow approach to defining the markets affected by the various infringements – the turnover used to calculate the basic fines varied significantly among the 120 markets the OFT identified, resulting in widely different basic fines for the same conduct. This is likely to have an impact on the OFT's future approach – it may adopt a wider definition of the relevant market in similar circumstances in future.
• The turnover used in calculating fines should have been turnover from the year preceding the infringement
  
  The CAT criticises the OFT for departing without proper consultation from its pre-2004 practice of calculating fines on the basis of turnover in the year before the infringement. It finds that the OFT's 2004 penalty guidelines do not make it clear that the OFT has switched to using turnover in the year prior to its infringement decision, and it finds that this was not highlighted in the OFT's consultation on the draft guidance. The OFT was not entitled to say that the statutory change in the basis for calculating the maximum fine justified its change in approach at earlier stages of calculating the fine, since the statutory change related to the affordability of the fine and not punishment and deterrence.
  
  Until the OFT issues specific guidance, therefore, it appears that the turnover it must use in future cases is turnover in the year preceding the year of the infringement. This may make a significant difference to a company's basic fine.
  
  The CAT also criticises the OFT's approach to calculating the penalty for Ballast. Ballast's turnover in the year preceding the decision had been zero, as it had withdrawn from the UK market. The OFT adopted a proxy of 0.14% of Ballast's global turnover as the basis for its calculation, taking the median of the step 2 penalties for all infringers, expressed as a percentage of worldwide turnover. The CAT finds that this produced an unfair result for a company that had less than 1% of its turnover in the UK. Although the CAT's discussion was academic (Ballast had generated turnover in the relevant market in the year preceding the infringement and so no proxy was required for the CAT's calculation of its penalty), and a proxy may be relevant only in rare circumstances, the OFT has a clear message that its approach needs to ensure fairness and take account of the infringer's specific circumstances.
• The OFT's blanket approach to increasing the basic fines for deterrence was wrong
  
  The most significant factor in the reductions in the six companies' fines is the CAT's rejection of the OFT's approach to increasing basic fines for deterrence. This made a massive difference in the level of fines, frequently increasing them by several hundred fold.
  
  The OFT has discretion to add a deterrence factor to a basic fine it considers is insufficient to deter the infringer and companies more generally from similar practices in future. The OFT's approach has been to apply the percentage seriousness figure to 15% of the turnover of the infringer's global group ("the MDT formula"), instead of applying it to the infringer's turnover in the market affected by the infringement. The deterrence factor is the difference between the two calculations.
  
  The CAT says that there is nothing inherently objectionable in the OFT's approach, but that the MDT is not a substitute for individual assessment of each case: the MDT should not be allowed to result in the imposition of a final penalty that is excessive and disproportionate.
  
  The CAT criticises the OFT's mechanistic, blanket approach:
  
  
  • The OFT applied the same formula to all companies without standing back and assessing the impact in individual cases, to confirm that in all the circumstances a penalty at the proposed level was reasonable and proportionate to punish the infringer and deter it and other companies from further similar breaches.
  • The choice of 15% of the infringer's global group turnover as a basis for the deterrence factor was not explained and was a "blunt instrument".
  • The OFT did not look at factors other than turnover, such as profits and cashflow – it noted the low margins in the construction industry and the fact that revenues often incorporated invoiced amounts for sub-contractor work.
  • Proportionality requires a balance between the culpability of the infringer and deterrence. The OFT did not ensure this balance. It is entitled to upscale the penalty for deterrence, but "culpability must not be lost to view".
    
    
  The judgment is likely to bring about a significant change in the OFT's fining practices – it will clearly need to consider a tailored approach to deterrence in individual cases. The fact that the CAT queries the OFT's choice of 15% global group turnover as the basis of the MDT formula, describing it as a "blunt instrument", must compel the OFT to give careful consideration to its continued use. The question is what, if anything, should take its place. It is interesting not only that the deterrence factors added by the CAT in each case were very substantially smaller than the deterrence factors applied by the OFT, but also that the CAT does not appear to have used any formula of its own in arriving at the appropriate figure.
• Discounts for compliance measures are acceptable
  
  The CAT indicates that post-infringement compliance programmes should be taken into account in assessing the deterrence factor, as they have a bearing on specific deterrence. The OFT has been reluctant to do this in the past, so it will be interesting to see how it applies this in the future.
  
  The CAT also states that it does not dispute the OFT's practice of awarding some mitigation discount for a post-infringement compliance programme, since this induces infringers to take appropriate steps to avoid infringing in the future. However, it indicates that, although the size of the discount will depend on the specific circumstances of the case, in most cases it is likely to be relatively modest in relation to the overall fine. In the majority of cases, the discount awarded by the OFT was 5%.
• Fraud by an employee does not negate or reduce the need for punishment or deterrence
  
  One of the six appellants, Bowmer, was found to have made a compensation payment to another bidder in relation to a tender Bowmer had won. The compensation payment had been arranged by a Bowmer employee without Bowmer's knowledge or consent. Since this was not a case of simple cover pricing, the company's penalty was higher – the OFT's starting point percentage was 7% rather than 5%. The CAT rejected Bowmer's argument that the penalty should be reduced on the basis that the company was the victim of fraud – the CAT said that the employee concerned had acted in Bowmer's interests. The CAT applied the 7% starting point to calculate the basic fine and then doubled the fine for deterrence.

The OFT now has a month from the date of the judgment in which to appeal to the Court of Appeal, on a point of law – and it must obtain permission either from the CAT or from the Court of Appeal before it can do so. In the meantime, the CAT's judgment makes it likely that the OFT will consider changes to its 2004 guidance, to include:

• broadening the range of starting point percentages;
• clarifying the turnover to be used in calculating penalties; and
• further guidance on the calculation of the deterrence factor.

It is also likely to consider changes to its practices, including a broader approach to defining the markets affected by the various infringements and a more tailored, proportionate approach to deterrence, balancing it against culpability in the case of each infringer. 

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