Risk & Economy » Regulation » Compliance – knock, knock

Executives of bus companies Arriva and FirstGroup must have thought they were doing a clever deal out of the public’s gaze when they met discreetly in a hotel room to fix up who would run a couple of bus routes in Leeds.

But they ended up booking their companies a place in business history as the first firms prosecuted under the 1998 Competition Act. Arriva picked up a £203,632 fine (reduced by 36% for co-operation) and FirstGroup escaped any direct financial penalty for putting its hand up to the Office of Fair Trading’s regulators. On the way, the companies also picked up all the management hassle associated with a 13-month investigation.

Welcome to the world of OFT investigations, where even a seemingly harmless nod and wink with business partners or competitors can bring an OFT hit squad crashing through your office door. In the past few years, the Competition Act 1998 and the Enterprise Act 2000 have strengthened anti-competitive laws in Britain significantly.

And the OFT has demonstrated it is quite prepared to use its tough new powers, which can result in companies being fined up to 10% of their global turnover with individuals – including staff and directors – facing unlimited fines, or up to five years in prison.

Anything that smells of sharp practice can have the OFT wielding its investigatory powers, as was the case last year when nine West Midlands roofing contractors tried to fix prices for flat roofing contracts in their area. Total fines: £300,000. Five suppliers in the insulated glass desiccant market picked up total fines of £1.7m last year, when they tried to fix prices charged to double-glazing firms.

But it’s not just the money that companies stand to lose when the OFT takes an interest in their dubious practices. “The key risk to businesspeople is to corporate reputation,” according to Edward Miller, a competition lawyer at Reed Smith.

The OFT’s remit spreads wide into reviewing mergers and other matters, but it is the investigations of anti-competitive agreements and abuses of dominant market positions which strike real fear into finance directors’ hearts, points out Neil Warwick, head of competition at law firm Dickinson Dees. “Anti-competitive agreements can encompass a wide range of things,” says Warwick. “For example, even tacitly agreeing to share markets – we’ll sell in this town, you sell in that one – is an offence.”

The dominant market test isn’t an exact science, but a rule of thumb is that 40% of an identifiable and discreet market – even in a smallish geographical area – constitutes dominance. “It doesn’t mean you can’t compete, but you can’t press the competition so aggressively – such as selling products below cost – that you’re trying to put them out of business,” Warwick says.

You may get a notice that the OFT is interested in your business practices. But the first time you know you’re under investigation may be when a secretary calls up to say the OFT investigators are waiting in reception, adds Peter Andrews, an associate in the competition team at lawyers Shoosmith.

Richard Powell, fraud investigation partner at KPMG, recalls the time he was called on his mobile at a conference. “The next speaker was ringing to apologise that he couldn’t make it because the OFT inspectors had arrived 30 minutes earlier. He wanted me there to help him.”

What’s really worrying it that there is next to nothing you can do about it if the OFT decides it’s going to launch an investigation. “If it’s going to happen, it’s going to happen,” says Andrews. “What the FD has to do is minimise the disruption and manage the process as carefully as possible.”

Do not, as one foolish company did, lock the inspectors in the lift. “Not a good idea, because it’s a criminal offence,” notes Andrews. You can ask the inspectors to wait until your lawyers arrive. “Their policy is generally to wait for a little while, but they’ll never wait for more than hour and, in my experience, rarely that long,” he says.

But just because the inspectors are in the building doesn’t mean you have to let them walk all over you. “You have rights as a company and you have to enforce your rights. At the same time, being too aggressive comes back to bite you,” Andrews says.

When the inspectors arrive, the first point is to look closely at their authorisation which will describe why they’re there. “It determines what material they can look at,” says Andrews. “They’re not allowed to come on a fishing expedition.” If they’ve come armed with a warrant, they will have tougher powers, such as the ability to search staff cars and homes, and to take away original documents.

Whatever the purpose of the raid, Powell says that FDs must try to manage it proactively. Andrews agrees and recommends the FD appoints a trusted member of staff to accompany each inspector and take copies of all the documents they confiscate so that the company knows what the OFT is looking at.

“It is better if you can set aside a room for the inspectors to work in,” says Andrews. “It insulates what is going on from the rest of the staff. Second, it is easier to keep tabs on where they are and what they’re doing.”

There are dangers in not monitoring what the OFT is doing, warns Powell. “I recall a case where a company simply supplied the OFT with whatever documents the inspectors had requested, without monitoring those documents properly. The OFT was originally investigating a matter relating to price concerns, but the documents enabled them to identify a range of other issues for investigation.”

Powell advises: “A proactive company would have ensured it took copies of all those documents and reviewed them together with someone who had experience of competition areas. The aim would have been to identify what other sorts of issues might come out. That’s important because you should always try to have the same, if not a greater, degree of knowledge than the investigator.”

Miller says it’s vital to keep focused when providing answers to questions the OFT asks. “Most of the investigation process will be the OFT submitting questions. In a typical investigation, you’ll get several sets of questions, as many as 30 at a time. And they can cover all kinds of information, including profit margins, license strategies and how products are sold. The OFT sets a time limit within which they want answers to their questions and it is no mean feat to respond to those questions because they can be pretty detailed.”

He advises: “You must be able to provide the best and most convincing evidence to influence the enquiry in the way that you want it to go, not to send back minimalist answers and hope it will go away. That is really the behaviour of the ostrich.”

Miller explains that the enquiry process is certain to last a few months and may drag on into years. All the while, it will be consuming valuable management time and resources, for which there will be no recompense even if the OFT finds there is no case to answer.

“In my experience,” says Powell, “it’s often a surprise – even to the most organised FD with a sophisticated finance department – how in-depth, detailed and probing requests for information can be. It’s not simply a question of providing the OFT with copies of the most recent management accounts. The problem is that the OFT may be asking for analysis of data not necessarily in the format in which the company would normally prepare it.”

The key, says Powell, is really understanding what the OFT investigators are getting at when they ask a question. “FDs understand numbers that show profits and losses. However, the sorts of issues which may be relevant in a competition or economic context are often going to involve quite different calculations. One example would be the profitability or contribution a particular product might have made in the context of an investigation into pricing. That could involve quite different methods of cost allocation than an FD might routinely use in the business.”

The most important thing is to provide the right kind of evidence. “Among the most persuasive evidence you can present are recent historical examples of things that happened in your market,” says Miller.

It’s a case of an ounce of practice being worth a tonne of competition theory. For example, if you can show that new entrants are entering a market with few barriers to entry, that would be a powerful argument to counter any allegations of market dominance. Of course, the best situation is not to attract the unwelcome attentions of the OFT investigators in the first place, but that is not always possible.

So it is not surprising that more companies are taking compliance much more seriously. Many are busy updating compliance manuals and training those staff whose actions could trigger an investigation. Andrews points out that some companies’ compliance policies include procedures for handling a dawn raid. “If it happens, they have the staff drilled, so they know what to do,” he says.

Warwick’s team sometimes ‘mystery shops’ its clients’ compliance procedures. That can involve studying minutes of meetings, where sensitive matters have been discussed, and then interviewing people who took part in the meetings to get more detail on what really took place. It can, says Warwick, sometimes reveal potentially worrying problems.

Looking ahead, Miller sees an even more worrying problem on the horizon – the threat of private actions against a company which has been successfully fined by the OFT. These are already starting big-time in the litigious US. “If a company is done for, say, price fixing, then previous customers can come along and claim they’ve been paying too much for their products for the past few years,” he says. “The real risk to a company is not so much the authorities’ investigation, but the rash of private actions that follow.”

Significant as a pointer for the future is the fact that British law firm Irwin Mitchell is currently organising a group action by direct and indirect purchasers of vitamin products against a dozen or so companies that have been successfully prosecuted in the EU and US as members of the “vitamins cartel”.

The problem for FDs is that both the law and practice in competition is developing fast. Regulators are keen to exercise their powers and, by and large, have public opinion behind them. “I wonder, frankly, whether a lot of companies know less about it than they should,” say Powell.


As if an aggressive OFT weren’t enough, Her Majesty’s Revenue and Customs (HMRC) will no doubt be anxious to strut its stuff when the merger is complete.

Chancellor Gordon Brown’s public reason for creating the giant department is to squeeze out administrative savings. The more significant, but barely mentioned reason, is to squeeze out more tax from corporate and individual taxpayers. Faced with looming budget deficits as far the eye can see, the Chancellor is keen to increase the tax take without raising politically sensitive tax rates.

He has also committed £150m to toughen up compliance measures. The merger of both departments will present a major integration challenge. But James Bullock, a partner in the tax litigation and regulatory practice at law firm McGrigors, says it also creates a number of posers for FDs.

For example, one significant issue still to be resolved is which department’s powers will be used for compliance visits. Under present law, Customs and Excise can turn up at business premises unannounced, whereas the Inland Revenue generally has to book at appointment.

But there are broader questions about the basic modus operandi of compliance officers in the new department. “Customs operate very differently to Revenue,” says Bullock. “Customs are used to dealing with nasty pieces of work – smugglers and hard-core criminals. But they’re going to have to adopt a nicer attitude when they walk into a FTSE company.”

Even so, rumour has it that HMRC will be keen to engage in some high-profile raids early in its life, if only to make its mark and pour encourager les autres. One particularly sensitive area, Bullock warns, is likely to be employment of casual labour. The Inland Revenue has set up a labour provider unit.

In the wake of the Morecambe Bay cockle pickers’ tragedy, the government is keen to bust the gang masters who supply cheap, and often illegal, casual labour. Any company that takes on casuals could unwittingly be in danger. It’s rumoured that two high street chains have already been raided.

“I think FDs have to take a careful look at their risk management, particularly in relation to staff hiring, whether permanent or casual, payroll systems and expense claims,” Bullock advises. “Just don’t assume it is all ticking over. Be absolutely rigorous and have risk management systems in place.

“A raid can be reputationally damaging and hugely disruptive to business and morale. If they take computers and software away, it can be chaotic. So get as close to your new HMRC officer as you possibly can, and find out what his or her agenda is. You might think a raid will never happen to you because you’re wholly innocent, but the fact is, they can and do take place,” warns Bullock.