James Farmer


Paper Presented on 2 August 2014 at the Competition Law & Policy Institute of New Zealand 25th Annual Conference

Tuesday, August 05, 2014

Jenny Stevens, the Chair of this session, told me a few weeks ago that she had a copy of “papers” I had given at Competition law conferences in 1992.  I had no recollection of having done that and she kindly sent them to me.  One of them turned out to be not a paper but rather a typed up record of an oral commentary that I had made of a paper given by John Fogarty (now Justice Fogarty) on the virtues of the Commerce Commission using what he called the “inquisitorial model” when dealing with authorisation applications.  As counsel for the Commission, John had previously made submissions to the same effect to the High Court in the landmark Fisher and Paykel case which was an appeal from a refusal by the Commission to sanction Fisher and Paykel’s exclusive dealing arrangements with its retailer network.  As an aside, Kerrin Vautier, who was then a member of the Commission, had dissented and the High Court drew liberally on her reasoning in allowing the appeal.

The notion that a tribunal whose decision was under appeal should itself appear as a party to defend itself – as opposed to leaving it to the parties to the dispute to present both sides of the argument – was at this time novel and John was very careful to say to the High Court that he was not addressing the merits of the Commission’s decision but merely explaining to the Court how the Commission’s procedures operated and why the inquisitorial process gave a better outcome than the adversarial procedures employed in the courts.  The subtle message, as I recall it, was “we know best”.  

Perhaps because the message was too subtle, in the cases that followed, the Commission, invariably represented still by John, took more and more an active role in appeals so that by the time that the Southern Cross Medical Trust case – an appeal from a refusal to grant a clearance for a proposed acquisition of a competitor – was heard in the High Court and Court of Appeal, the pretence of being there just to assist the Court on the procedures employed by the Commission had been completely abandoned and the Commission became a full-on adversary to the appellant.  And so it has been ever since, although the Commission along the way somehow obtained a ruling that says that costs on appeals cannot be awarded against it if it loses but, conversely, it is entitled to costs if it wins.

Returning, however, to the typed notes of my commentary in 1992, I was somewhat dismayed to find how rude and disrespectful I had been at the time about the Commission’s “inquisitorial” processes. Having spent the last 2 days appearing for the Commission in the Court of Appeal in the Chorus broadband pricing dispute, I think it only appropriate today to apologise to the Commission for those unkind remarks made some 22 years ago.  In mitigation, I would say that what had provoked me was a Commission conference at which counsel were not allowed to ask questions of witnesses called by opposing parties and I had had to sit mute while a so-called Business Development Manager of a telecommunications company, who never disclosed what qualifications (if any) he had expressed lengthy opinions on matters technological, social, political, economic and legal.  There was of course questioning from members of the Commission and in my Notes I recorded with approval a question from a Commission member to an Australian telecommunications economist which went something like this: “What are you, an economist or what?”  My comment of that was: “That question I did approve of though I would regard it as improper myself to put it in such an obviously offensive way”.

What emerges from my Notes in 1992 of greater substance were the implications of the sea change that had occurred at that time as a result of the regulatory reforms that the Labour Government had introduced after its election in 1984 under the direction of the then Minister of Finance Roger Douglas.  Prior to that time, and particularly during the Muldoon years, the New Zealand economy was characterised by what on any measure would be called heavy-handed regulation.  The Control of Prices Act of 1957 and the Trade Practices Act of 1958 and even the first Commerce Act that succeeded it gave competition in markets little if any role.  Instead a variety of Government and regulatory bodies used administrative processes to enforce detailed regulations that were largely focused on controlling prices but without any regard to any coherent economic policy or principles.  Over the top of all those measures sat the Economic Stabilisation Act 1948 which empowered the Government at any time to introduce statutory regulations that controlled or regulated any sector of the economy.  These powers were used many times particularly by the Muldoon Government to impose price and wage freezes or to control and limit increases in prices and wages.  I recall during my years at Russell McVeagh in the 1970s earning considerable revenues for the firm by writing opinions for corporate clients on the meaning and effect of each successive amendment (of which there were many) to the Price Stabilisation Regulations and to the Wage Adjustment Regulations.

The enactment of the Commerce Act in 1986, following its counterpart in Australia with their Trade Practices Act, not only elevated market competition to the forefront of regulatory instruments but it also gave the High Court a new and more important role as the enforcer of the new Part II provisions, principally sections 27 and 36.  That constituted a leap of faith in the ability of generalist Judges with no experience or learning in economics or even in principles of competition law to cope with the new jurisdiction.  The appointment of lay members (sometimes but not always economists) to assist them was obviously a measure intended to alleviate any deficiencies that Judges might have and there is no doubt that the contribution made by Maureen Brunt in the early years and Kerrin Vautier in later years has served to ensure that the Judges do not get it totally wrong.

Nevertheless, the use of Judges and adversarial processes so much deprecated by John Fogarty in this context has always been a controversial one.  I had cause, when researching and writing on the operation of administrative tribunals in England academically [Farmer, Tribunals and Government (Weidenfeld and Nicolson, London, 1974)], to read the Debates in the Commons when the Restrictive Practices Court was established in 1956 and the Judgments of that Court once it had been established.  The views that were expressed were that, even with the assistance of lay members with commercial and industrial experience, a Court presided over by a High Court Judge and using judicial processes, was ill-equipped to make judgements on what were essentially economic issues requiring policy judgement.  What was said of the decisions of the Restrictive Practices Court was that they were legalistic and paid insufficient regard to the economic consequences of the decisions that were being given.

The New Zealand solution to these concerns was the importation of high powered economists to give expert evidence on the appropriate and relevant economic principles and on how those principles were best applied to the facts of the particular case before the Court.  Philip Williams was prominent in New Zealand court cases then as much as he still is now.  I have had daunting task several times of having to cross examine him, beginning first with Magic Millions in the early 90s and more recently in the air cargo case.  On a larger scale, we have also seen many of the top American antitrust economists in New Zealand courts.  The first of these that I recall using was in 1986 in the case of Fletcher Metals v. Commerce Commission (in which, interestingly, the Commission was not represented but an amicus from Crown Law was appointed).  Then in Fisher and Paykel, we brought in Ben Klein from UCLA, who was later to give evidence in numerous other cases, and Professor Bill Baxter who was a lawyer by training but who had become an economist in all but name and who was famous for introducing the Merger Guidelines when occupying the position of Attorney-General.

Others followed, most notably Professors Baumol and Willig and Dr Alfred Kahn in the Telecom-Clear interconnection dispute that went to the Privy Council.  Terrence Arnold (now Justice Arnold) and I visited Baumol and Willig in their University rooms at NYU and Princeton and they explained what came to be called the efficient component pricing principle (ECPR) on blackboards using railroads as an example of granting access to a competitor in return for a profit foregone. Terrance and I were mindful of the fact that this approach would not address the problem of monopoly profits being earned by the incumbent monopolist except (if at all) over time but the Baumol answer was simply that ECPR was only designed to ensure a level competitive playing field and any concerns about monopoly profits would need to be addressed by regulation (which, as the Privy Council said, was of course completely consistent with the structure of the Commerce Act with its Part 4 price control provisions). John Fogarty by this time was acting for Clear Communications and became frustrated when Baumol, when cross examined on the fact that ECPR didn’t deal effectively with monopoly profits, continually rejoined with: “ECPR addresses competition.  It does not solve the problems of AIDs, baldness, economic cycles or monopoly profits.”

The litigation between Telecom and Clear did eventually lead to the negotiation of an old-fashioned and unprincipled interconnection agreement between the companies that was pragmatic and the terms of which heavily favoured Telecom consistently with its far greater market power at the time.  Ironically that became the genesis of what later was known as the 0867 litigation after the internet revolution gave Clear the opportunity to turn the agreement to its advantage.

The costs of the Telecom-Clear battle were clearly considerable although of course the stakes were also high.  There was also in the mid-90s the further long trial in the Kapuni Gas case, which was determined under section 27 and again saw the importation of a considerable number of US economists, including Klein, David Teece, Dennis Carlton and Jerry Hausman who has been here many times since.  Justice Barker, who heard the case with Gair Blunt as lay member, in the Court’s Judgment expressed dismay at what he clearly saw as an over-use of economists.  He expressed, both during the trial and in the Judgment, irritation at what he called the “exhaustive and exhausting” cross examination of one of the economists on the arcane sub-discipline of econometrics.  

Nevertheless, economists and particularly those from the United States continued to be used. A large number of them including Willig, Professor Ordover from NYU, Carlton and Bamberger, filled up a whole jury box in the appeal by Air New Zealand and Qantas against the refusal of the Commission to grant an authorisation to a proposed alliance.  By this time, the hot tub had become a standard procedure for dealing with the presentation of economic evidence.  First used in Australia and so-called by Justice Lockhart in the Federal Court, the hot tub developed its own New Zealand form as a result of an agreement between David Goddard and me which came to be called the Farmer-Goddard twist.  Under this variant, it was open to the cross examining counsel to refer an answer from the opposing economist to one of his economists for comment.  This procedure was stated by its authors to be used only sparingly.  It has, in the view of the authors, worked very well, while requiring the exercise of considerable control to ensure that it doesn’t quickly descend into a shouting match between the economists concerned.

Notwithstanding increasing concerns as to the length and utility of Part II cases, several further lengthy trials took place.  There were the Port Nelson cases, the dispute between the Commission and Bay of Plenty Electricity, the 2 battles between the Commission and Telecom in 0867 and Data Tails and, more recently Todd v. Shell and OMV, which after an 8 week trial is to be heard further in the Court of Appeal next month over 8 days of hearing time.  As is well known, 0867 went to the Supreme Court which, despite 4 days of careful argument from both sides, gave a short and superficial judgment which, building on dicta by the majority in the Privy Council in Carter Holt,  wrongly stated that the approach in New Zealand and Australia to the exclusivity of counterfactual analysis was the same and which failed to grapple with problems that have arisen with that way of testing the issue of use of market power.

By the turn of the century, there was in any event a growing realisation that in industries that were characterised by the existence of natural monopolies or where there was an incumbent whose market power was difficult to dislodge by the normal forces of competition, the Commerce Act in its original form at least was not going to be sufficient.  The Fletcher Inquiry into Telecommunications in 2000 said in this respect:

Most market participants would argue that the Commerce Act, in its current form, has not proved adequate to address the imbalances in market power that characterise some parts of the electronic communications industry.  Moreover, even if liability under the Act can be proven, it may take several years before all appeal rights are exhausted, and the range of remedies that the Courts can impose is very limited.  It follows that action under the Commerce Act may be suited to dealing with past wrongs, but can be ineffective when it comes to “nipping problems in the bud”.

The Fletcher Report led fairly rapidly to the passing of the Telecommunications Act of 2001.  That was followed by reforms to the Commerce Act in the form of a new Part 4A which introduced direct regulation into the electricity sector.  Part 4A was itself reformed in 2009 by a new Part 4 which contained specific regulation dealing with electricity lines businesses, gas pipelines and airports as well as a framework for price control and including provisions for negotiation and arbitration and information disclosure regulation in any industry.  It also contained a process of determining input methodologies for valuing assets, allocating common costs, determining the weighted average cost of capital (WACC) and other components used to determine a reasonable return.  That led to the truly exhausting input methodologies appeal heard by Justice Clifford in the High Court assisted by two Australian lay members and an 800 page Judgment which upheld almost completely the various reports in relation to the energy and airport sectors brought down by the Commission.  That outcome was in a sense hardly surprising given the fact that under the statute no new evidence could be brought before the Court so that the Commission’s record was sacrosanct and further that the onus was on appellants to show that a different approach would have been “materially better” than the methodology used by the Commission.  What thus had the appearance of a merits review by the High Court was to that extent illusory.

In his Frank Guest Memorial lecture at Otago University in 2009, James Every-Palmer traces what he calls a “sea change” from regulation by competition as contained in the Commerce Act in its original form “towards price control regulation and similarly invasive controls” [(2010) 12 Otago LRev 227].  As he puts it:

The reforms have ... tended to be reactive rather than pro-active.  That is, like a pendulum we saw an extreme form of light-handed regulation introduced in response to the regulatory excesses of the Muldoon era.  The resulting access disputes and concerns about "excessive" pricing has led to ... rapid re-regulation...

James makes the valid point that this rapid increase of economic regulation means that “the Courts’ role is now more likely to be in reviewing the regulator than in reviewing the party with market power”.  The Courts have been reluctant to allow the use of judicial review and appeals that are limited to questions of law to be used as a vehicle for challenging regulatory decisions given the invariable attempts of plaintiffs to broaden such claims into merits review where that is not permissible under the relevant statute.  That will generally be justified (e.g. Unison v. Commerce Commission) but there are certainly some cases where the Judges have perhaps been unduly cautious and where their own unfamiliarity with regulatory jurisdictions has led them to reject the claim (cf. Genesis v. Electricity Commission, Air New Zealand v. Wellington Airport).

Perhaps recognising this, Every-Palmer advocates the establishment of general merits review by a specialist High Court from the decisions of regulators.  I would agree but also share with him his obvious disquiet at the limiting effects that the input methodologies model has.  Merits review, if it is to be effective, must allow the leading of further evidence, even if only of an updating kind but also, importantly, including expert evidence that can be tested by cross examination.  Critical also to any such reform must be an abandonment of the idea that all High Court Judges are capable of picking up the complexities of these regulatory issues.  A specialist court is essential.

There is always much discussion at these conferences about the inadequacies of section 36 of the Commerce Act.  For myself, I think the outcome of the Data Tails case (as well as earlier cases such as Magic Millions) does demonstrate that section 36 cases are winnable, notwithstanding the disappointing analyses by the Courts in 0867 and by the artificial and unnecessary blinkers that were imposed on the “use of market power” issue by the Courts’ technical application of the counterfactual instrument.  The reality is though that section 36 has now lost its place of prime importance in competition regulation by reason of the regulatory developments that have occurred and can be expected to continue to occur.  

Postscript: This posting is a good occasion to pay tribute to some of the competition lawyers that I have regularly encountered in the many competition cases in court which I have been engaged in over the past 25 years.  I have referred to John Fogarty (now Justice Fogarty) above who appeared regularly for the Commission and then for Clear Communications.  Alan Galbraith QC was unkind enough to say that my use of Courtroom tactics that I had learned at the Sydney Bar aged John and caused him to go grey prematurely.  Not so.  John always had an aged dignity and charm about him that took anything that I threw at him in his stride.  Next for the Commission in a number of cases was Douglas White QC (now Justice White of the Court of Appeal).  A terrific long-fought battle in Commerce Commission v. Fletcher Challenge and others before McGechan J on a merger, asset divestment case and then a challenge by Telecom in the High Court and Court of Appeal to a report by the Commission into the telecommunications industry in which the Commission (unlawfully, as it was held) described Telecom as the de facto regulator of the industry.  Brendan Brown QC (now Justice Brown), who I first encountered in Magic Millions and who (correctly) described Franklin Fisher’s work “Diagnosing Monopoly” as “wonderful really”, later became the Commission’s counsel of choice for a long period.  He was fond of citing at length in cases in which I was against him the Court of Appeal’s Judgment in Port Nelson, knowing full well that that was one case in which I had not appeared.  In BOPE he took advantage of the fact that the Judge was newly appointed and had not been a litigator in legal practice to persuade him not to accept my key documents into evidence but to place them in a “library” – truly!  It took something of a tantrum from me eventually to get them from the library into evidence.  Finally I should mention David Goddard QC who, as a young lawyer, was Alan Galbraith’s junior in the Kapuni Gas case but who later appeared for the Commission many times and notably in the Banks Credit Cards case before being seduced in recent times by the monopolists to act against the Commission.  As referred to above, David and I think are entitled to take credit for developing the hot tub process.

On the same side, I have also been fortunate to work with many talented lawyers on these cases.  At the risk of omitting a number of them, I would mention (in no particular order) Terrence Arnold (now a Judge of the Supreme Court), Forrie Miller (Judge of the Court of Appeal), Chris Finlayson (now Attorney-General), Andrew Peterson, Andrew Matthews, Anna Rawlings (now a Commerce Commissioner), Miriam Dean QC, Gillian Coumbe QC, David Blacktop (now counsel with the Commission), Suzanne Robertson, Iain Thain, David Cooper, Anne Callinan, James Craig,  James Every-Palmer, Mark O’Brien and 2 who became High Court Judges from which positions they have now retired – Rod Hansen in Fletcher Metals and Chris Allen (who later became Justice Allen of the High Court and who appeared with me in Fisher and Paykel).

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