China - Cartels
In 2017, China’s antitrust authorities continued their record of active cartel enforcement. Building on the high-profile cases and legislative initiatives of recent years, the National Development and Reform Commission (the NDRC) and the State Administration for Industry and Commerce (the SAIC), together with their regional offices, have further solidified their position as serious and active cartel enforcers to be reckoned with worldwide. The NDRC and the SAIC have distinct but often overlapping enforcement authority over different forms of anticompetitive conduct under China’s Anti-Monopoly Law (the AML).1 More specifically, the NDRC has enforcement authority over price-related anticompetitive agreements such as horizontal price fixing. The SAIC is responsible for enforcement related to non-price restraints such as market allocation and output restrictions.
Over the past year, these authorities have reaffirmed their hard stance in targeting cartels. These cases have allowed the authorities to further define and establish their investigative practices and precedents on key issues facing companies doing business in China. At the same time, under the oversight of the Anti-Monopoly Commission, the authorities have continued to test the draft antitrust guidelines, which are intended to give more transparency to enforcers and market participants. These guidelines will give more clarity on key aspects of cartel enforcement procedure, including leniency applications, liability exemptions and calculation of fines/illegal gains, as well as substantive guidance on cartel enforcement in the auto sector and intellectual property context. Once enacted, these new rules will continue to shape the cartel enforcement and compliance landscape in China.
This article reviews these key developments in cartel enforcement in China and discusses the significance of these developments for businesses. The article begins by outlining the authorities’ positions on key substantive issues in the context of important enforcement cases and the draft enforcement guidelines. The article then highlights the procedural developments that have allowed regulators to investigate and prosecute violations more effectively, while noting some areas where further development is required. Finally, the article extrapolates from the review some relevant enforcement trends and discusses the implications for companies operating in China.
Horizontal agreements – particularly traditional hardcore cartel agreements – have been an enforcement priority for both the NDRC and the SAIC since the AML came into effect. So far, these horizontal agreements have accounted for a majority of the authorities’ enforcement actions. While the enforcement of horizontal agreements traditionally focused on local violations by domestic private companies, enforcement in this area is becoming increasingly active in also targeting multinational and state-owned companies.
Price fixing, customer and market allocation, output restrictions and joint boycotting are explicitly prohibited as monopoly agreements under article 13 of the AML. Horizontal agreements do not have to be oral or written contracts, but rather can take various forms: joint announcements, commitments, self-discipline policies or other concerted action.
Article 15 contains a non-exhaustive list of circumstances in which a monopoly agreement may be exempted, specifically where the challenged agreement is concluded for:
- improving technology, or researching and developing new products;
- improving product quality, reducing costs, enhancing efficiency, harmonising product specifications and standards, or dividing work based on specialisation;
- enhancing the competitiveness of small- and medium-sized enterprises;
- serving social public interests such as energy saving, environmental protection and disaster relief;
- alleviating decreases in sales or cuts in production overcapacity in periods of economic downturn; or
- safeguarding legitimate interests in foreign trade.
Each of the first five conditions additionally requires that the agreement does not significantly restrict competition in the relevant market and allows consumers to share the resulting benefit.
As with other jurisdictions, horizontal monopoly agreements are subject to close scrutiny and the authorities place a substantial burden on the parties to a traditional hardcore cartel agreement to prove such agreement falls within these exemptions. In fact, there is yet to be a published case to date where an anticompetitive horizontal or vertical agreement has been exempted of penalties by virtue of article 15.
It is noteworthy that, in practice, cartel agreements are often intertwined with vertical restraints under article 14 of the AML, particularly resale price maintenance (RPM) arrangements. For example, in the Mercedes-Benz case in 2015, the car maker was found to have organised dealers to fix resale prices for Mercedes-Benz parts as part of a hub-and-spoke conspiracy. The NDRC considered that while the dealers undoubtedly had participated in a cartel, Mercedes-Benz should be more appropriately considered to have engaged in RPM practices because it had organised the conspiracy as a means to achieve vertical price control.
Key enforcement cases in 2017
Despite releasing fewer high-profile decisions imposing large fines during 2017, global and domestic cartels have remained on the top of enforcement agenda and the authorities continued enforcement momentum. In the Polyvinyl Chloride (PVC) case, 18 manufacturers of PVC were alleged to have engaged in cartel conduct through a local consortium. In particular, NDRC found that Hubei Yihua and China Salt Jilantai organised a series of meetings between the manufacturers in 2016 where they discussed sensitive information on pricing and production, with 13 instances where they agreed on price increases. The NDRC levied a fine of 2 per cent of last year’s relevant turnover on Hubei Yihua and China Salt Jilantai as the leaders of the cartel, and the remaining 16 manufactures each received a fine equivalent to one per cent of last year’s relevant turnover. The aggregate fines of 457 million yuan represent the largest ever fines imposed on domestic Chinese companies in a single case.
The authorities have also hardened their stance towards industry associations amid the crackdown on cartels. In China, industry associations historically were quasi-governmental entities and nowadays still play an important role in many sectors. In the cartel enforcement in the past years, there have been a number of occasions where collusion between competitors was found to have been conducted under the auspices of industry associations. In the Fuyang paper case in 2017, for example, NDRC found that the Fuyang Paper Association organised a conspiracy between 17 paper makers to raise price and policed its implementation. The Fuyang Paper Association, which had been penalised for similar conduct in 2010, received an aggravating penalty and was ordered to be deregistered. Given industry associations’ prevalence in China’s economy, the NDRC issued a set of guidelines in 2017 to provide further guidance to industry associations on a wide array of conduct, such as influencing member companies’ prices, facilitating information exchange, and engaging in joint action with other trade associations. In particular, the guidelines identify certain types of conduct that involve high or very high risk of anticompetitive behaviour, including, among others, publishing price information that could influence the general public’s price expectations or lead to collusion among players in the same industry.
With more enforcement experience, the investigative practices and procedures are becoming more defined. In the process, the authorities and their provincial offices have been developing internal procedural guidelines. There have been some notable improvements in relation to due process. They also have improved transparency during the course of the investigation and established the customary practice of publishing more reasoned decisions.
Investigations may originate from various sources at both the provincial and national levels. As in other jurisdictions, complaints from competitors, customers or suppliers tend to be the most important sources of investigations. In addition, if an ongoing investigation by other administrative authorities reveals indications of antitrust law violations, relevant leads may be transferred to the NDRC or the SAIC and an antitrust investigation may ensue. The NDRC has also conducted broader sector inquiries swiftly followed by investigations into infringements by individual companies. In such inquiries, the authority first sends generic questionnaires to a variety of market players and subsequently targets certain companies for follow-up inquiries or even formal investigation.
At the start of an investigation, the NDRC and the SAIC will typically conduct a dawn raid of the target businesses. Officials from both authorities have relatively broad investigatory powers under the relevant regulations and the authorities’ general enforcement practice. As the authorities gradually accumulate experience, their investigative skills are becoming increasingly sophisticated. The NDRC in particular has developed task forces to carry out the dawn raids and follow-up investigations, including a range of specialised experts in law, technology and accounting. They have also been using increasingly high-tech investigative techniques, including forensic IT techniques to quickly recover deleted emails.
A notable feature of the cartel enforcement activities in 2017 is that the authorities used WeChat (a very popular messaging application in China) for evidence to prove the existence of a conspiracy in the PVC case. The decision does not elaborate on how these records were seized. Even for personal phones, authorities may take the position that use for business communications would be sufficient to bring it within the scope of the search. As business communications increasingly take place on WeChat in China, it can be expected that WeChat and other messaging services will become an important target for evidence in the future.
Following the initial dawn raid or meeting with a target, the investigation will typically continue through a series of engagements with the company. Investigations may entail a series of information requests and site visits supported by interviews with relevant employees and collection of a significant amount of documentary evidence. The authorities will also typically engage with the target of the investigation on potential settlements or remedies from an early stage, reportedly seeking admissions and cooperation under the leniency rules to support the settlement. In the PVC case, for example, the NDRC reported that the investigation involved 78 meetings over a span of eight months involving more than 200 law enforcement officers from 11 provinces. In many cases, the NDRC will also direct the company to conduct an internal audit or compliance review as a basis for reporting on its conduct.
After the case team completes the investigation, they are directed to prepare an internal recommendation based on the relevant evidence and any explanations or defences raised by the parties. The authority issues an advance penalty notice to the target if it concludes there is a violation of the AML, setting out the basis for their findings and the proposed penalty. The target then has the formal right to respond and request a hearing on the merits. Finally, the parties have a formal right to seek administrative reconsideration or judicial review of an unfavourable final penalty decision.
The pace of the investigations can vary dramatically. While some cases have had final decisions announced only a few months from the launch of the formal investigation, other cases have reportedly lasted several years. There is also no formal mechanism for limiting the scope of the investigation. Although article 43 of the AML provides that parties under investigation have a formal right of defence, in practice, defendants may only be given a limited window to present defences. Both the NDRC and the SAIC have also confirmed that the parties under investigation have a formal right to external counsel and the authorities generally accept that foreign lawyers participate in antitrust investigations. Since attorney-client privilege protections do not apply in China, however, communications with counsel are not protected from disclosure to the same extent as in other jurisdictions.
The AML provides substantial penalties for non-compliance with investigations. Specifically, article 52 provides for fines of up to one million yuan for the obstruction of an investigation, including concealing, destroying or falsifying documents. In 2017, for example, the Shandong office of NDRC imposed a fine of 120,000 yuan on Longshunhe Pharmaceuticals for obstructing an investigation where it found that a business manager threw away a flash drive containing data collected by the officials, and other employees sought to prevent the officials from retrieving it. Failure to cooperate can damage a company’s credibility and exacerbate potential fines. The authorities are also entitled to impose fines against individuals, as well as criminal penalties of up to three years’ imprisonment.
Calculation of fines
As cartel enforcement becomes more active, more cases involving big companies and significant penalties are likely to be seen. Article 46 of the AML provides that the applicable fine should be assessed at one per cent to 10 per cent of the offending company’s relevant sales revenue for the preceding year. The authorities are also entitled to confiscate alleged illegal gains, which can be significant and even exceed the amount of the fine. The NDRC is currently developing the Draft Guidelines on the Calculation of Fines and Illegal Gains (Draft Fine Guidelines) to provide more clarity as to how fines and illegal gains should be set properly and a draft was published for public comment in 2016. While the Draft Fine Guidelines are subject to revision before they are adopted, they give some insight into the current framework applied by the NDRC.
The first step for fine calculation is to determine the amount of the relevant sales for calculating the fine. The Draft Fine Guidelines provide that this would usually be the annual turnover generated by the sales of the relevant products in the year before the investigation started. The relevant geographic scope is all areas where the cartel took place. If it is an international cartel, the authorities will limit the basic amount to Chinese domestic markets. The Draft Fine Guidelines would also give officials discretion to use a larger base amount up to the company’s total turnover, if the turnover of the relevant product is not an objective reflection of the harm to competition and consumer interests. Such adjustments may be made, for instance, if:
- the infringing conduct is severe and has caused serious harm; or
- a company has engaged in a global anticompetitive agreement but achieved no or limited turnover for the relevant product within China.
The authorities will then set the level of the fine based on the nature and duration of the conduct. The guidance states that the base fine should start at 3 per cent for price fixing, market allocation and output restrictions, and two per cent for other types of horizontal anticompetitive agreements (including restrictions on R&D and joint boycotts). The percentage will then be increased or decreased depending on the duration and seriousness of the relevant cartel conduct, and any aggravating or mitigating factors. According to the Draft Fine Guidelines, aggravating factors include situations where a company plays a major role or coerces or tricks other companies into the cartel, prevents other companies from ceasing cartel activities, or engages in multiple conspiracies. Mitigating factors include situations where a company is coerced into joining or remaining in the cartel, has provided significant cooperation with the authorities during the investigation, or has proactively eliminated or mitigated the anticompetitive effect of the conduct.
In addition to fines, the potential penalties imposed through the confiscation of illegal gains can be significant. This is particularly seen in the SAIC investigations. Illegal gains sometimes can be significantly larger than fines, because illegal gains under the Draft Fine Guidelines include the entire benefits an infringing company has obtained for the whole duration of the infringements, while fines only reflect a certain proportion of the company’s turnover in the preceding year. In the Cipher Device case in 2016, for example, one of the infringing companies received a relatively light fine of 76,000 yuan, but the illegal gains confiscated by the SAIC were more than 250 times higher at approximately 20 million yuan. Such disparity is primarily due to the fact that prior to the sanctions the market division scheme had operated for five years and the parties had generated large profits during these years that the SAIC found they would not have made absent the market allocation conspiracy.
The Draft Fine Guidelines also propose rules on other important issues. For example, the authorities will normally impose sanctions on the entity which engaged in the anticompetitive conduct; if, however, the parent company exerted decisive influence over such entity’s conduct, the parent company can be subject to penalties instead. When determining whether the parent company has exerted decisive influence, the authorities will evaluate the parent’s control over the subsidiary’s operations, taking into account the shareholding, composition of the board of directors, governance arrangements, management system, resolution protocol, as well as the investment relationship, agreement or other arrangements which can prove the existence of actual influence. If the authorities seek to impose parental liability, the basic amount of the fine could increase significantly.
Article 46 of the AML requires the ‘reporting of information on an anticompetitive agreement and provision of important evidence’ as a precondition of partial or full leniency. The draft Guidelines on Application of Leniency Regime in Horizontal Monopolistic Agreement Cases (Draft Leniency Guidelines), which are being prepared by the NDRC, provide detailed guidelines on a number of key issues.
According to the Draft Leniency Guidelines, a leniency application can be made to the authorities before or after an investigation is officially launched. The applicant should submit a report with details about the cartel arrangements and provide important evidence in the case. ‘Important evidence’ refers to evidence that is not yet known to the public but is sufficient for the authorities to launch an investigation, or, if an investigation has already been launched, evidence that can add significant value to the determination of the cartel conduct. To be eligible for leniency, an applicant should:
- cease the alleged cartel activities unless permitted by the authorities to continue for the purpose of protecting secrecy of the investigation;
- fully cooperate with the investigation;
- safeguard and provide evidence and information and refrain from concealing, destroying or transferring materials; and
- not disclose the fact that it has applied for leniency.
The Draft Leniency Guidelines provide that only a maximum of three firms can be granted leniency in the same case. However, in complicated cases where many undertakings are involved and the applicants provide different but important evidence, the authorities have the discretion to grant leniency to additional applicants. The authorities will determine the chronological order of multiple leniency applications and inform each applicant of its position. When an applicant fails to fulfil its obligations mentioned above, it can be moved down in the queue or even disqualified altogether.
The first applicant is entitled to full immunity if the application is made before the investigation is launched and will otherwise receive a fine reduction of at least 80 per cent. The second applicant will receive a partial immunity with credit for a reduction of 30–50 per cent of the fine. The third and subsequent applicants (if any) will receive reductions of no more than 30 per cent of the fine. The authorities have the discretion to decide whether to also apply these discounts to confiscation of unlawful gains. In the Global Roll-on/Roll-off shipping case in 2016, for example, Nippon Yusen Kabushiki Kaisha was subject to fines at the highest end of the range at 10 per cent based on its leading position and the duration of the conduct, but then granted full immunity as the first company to report to the NDRC. The second and the third leniency applicants were entitled to a fine reduction of 60 per cent and 30 per cent, respectively.
The active enforcement and legislative progress relating to cartel investigations in 2017 continues to strengthen the regime that has been taking shape over the past few years. The NDRC and the SAIC have been actively drafting new rules, expanding enforcement capacity, working more closely with foreign regulators and accumulating experience. On the substantive side, both domestic and international cartels are likely to continue to be an enforcement priority. In the meantime, further guidance is expected to provide more clarity and predictability to the business community on many important substantive issues. In terms of procedure, the authorities have gained experience in relation to conducting investigations and have taken a hard line on non-cooperation during investigation.
Against this background, robust cartel enforcement is expected to continue. Companies doing business in and with China cannot afford to overlook this jurisdiction in their global competition compliance programmes. They are advised to follow the developments, closely examine their business practices, carefully assess the associated risks and take necessary actions to address any non-compliance.
1 In addition to competition enforcement under the AML, the NDRC and the SAIC also have enforcement authority over related statutes like the Anti-Unfair Competition Law and the Price Law.