A federal investigation could be about to uncover a huge antitrust scandal in the ad industry

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Earlier this month The Wall Street Journal revealed the US Department of Justice (DoJ) has opened up into an investigation into whether advertising agencies are intentionally rigging the bidding process for TV and video commercial production contracts to favor their own in-house companies, rather than independent production outfits.

IPG confirmed one of its "standalone domestic [agencies]" is cooperating with the investigation and has been asked to hand over documents. Omnicom said two of its subsidiaries have received subpoenas from the DoJ concerning its investigation into video production and post production practices and that it too is cooperating with the authorities. Publicis Groupe issued a statement after this story was initially published confirming one of its subsidiaries received a subpoena on December 14 and that it is collaborating with the investigation. All of the other "big six" advertising holding companies — WPP, Dentsu, and Havas — have declined to comment about whether any of their agencies are involved.

It sounds complicated. And it is. But the investigation could have huge repercussions on the entire advertising industry, that stretch beyond the estimated $5 billion production sector.

People could go to prison. 

Here's why.

What is bid rigging and why is the DoJ probing ad agencies and production companies over it?

This is what should generally happen when a brand appoints an ad agency to work on a commercial. The agency is responsible for the big, strategic, creative idea. But a production company is responsible for filming the commercial, directing the shoot, and a post-production company provides services such as visual effects and editing.

The ad agency agrees with their client that they will put the production work out for competitive pitches among a number of production companies. Interested companies bid for the work by naming their price. The ad agency recommends which production companies they think the client should choose. The client picks what seems like the most suitable company, with the most reasonable price to take on the work.

But here's where it gets a bit muddy.

Many agency holding companies have bought or built out their own production and post production companies, often under different names to the ad agencies they sit within. They want to get the work themselves, rather than seeing it lost to the independent production company sector. Good players want to win this work fairly, by having the most talented employees — directors, colorists, sound engineers, visual effects artists, and so on — and the best body of work.

But the DoJ is looking at whether some ad agencies are using dubious illegal methods to make sure they win those production budgets. We spoke to a number of advertising industry sources and it appears this is the kind of scenario the DoJ is looking at.

An ongoing joke in the industry is: You give away the ideas for free, you make the money on production. As brand procurement departments have squeezed the prices down on services such as strategic insight, planning, and account handling, agencies have looked for new revenue streams as they attempt to keep their margins healthy.

Ad agencies work with independent production agencies all the time. But there is also an industry term often thrown about called "make weights."

Here's the kind of hypothetical situation the DoJ is looking for: Ad agencies ask two of their independent production company pals to submit a bid for the work — usually something fairly high so the client is never likely to consider it. The creative agency offers the production companies the promise of work in the future, or threatens they may get no work from them in the future, or maybe even offers some sort of payout in return for playing along with the game.

Two "competing" bids of, say, $310,000 may justify the in-house ad agency's seemingly high production fee of $250,000 to the client (even though the work could have probably been completed for far cheaper than that).

What was just described is bid-rigging and price-fixing — both of which are illegal in the United States under federal antitrust law.

The prosecutor looking into this investigation has sent ad executives to prison before

Rebecca Meiklejohn, the DoJ attorney leading this investigation, has trodden this ground before.

In the early 2000s, Meiklejohn led an investigation into bid-rigging among printers who work ad agencies. She used informants wearing hidden microphones to collect evidence, in addition to flipping low-level offenders to testify against bigger fish on Madison Avenue. 

She indicted 22 ad execs and got convictions in 21 of those cases. Most famously, Grey Global Group executive vice president for print Mitch Mosallem was sentenced to a term in federal prison for 70 months. Haluk Ergulec, the former owner of Color Wheel, a New York print shop, was imprisoned for 37 months. The others paid millions in fines and restitution, collectively. 

Since the mid-1990s, Meiklejohn's office has prosecuted about 60 different ad execs in various anti-competition cases, going all the way back to Harold Singer, the notorious print boss of Wells Rich Greene. Back in the Mad Men era, Singer spent so much money on steak and vodka with his co-conspirators at the Palm Too restaurant in Manhattan that the restaurant owner painted his face into a mural on its wall. He pled guilty to conspiracy to defraud the IRS, and got three years' probation.

Print production and TV commercial production are completely different businesses, but they both have one thing in common: The companies' clients are ad agencies, and those agencies' clients generally insist on seeing multiple competitive bids on their work before they choose a vendor.

Rigging the bids — colluding to fix bid prices so that you know which one will win before the client sees them — is a straightforward violation of federal anti-competition law. Those cases fall squarely onto Meiklejohn's beat inside the DoJ. So she is likely to be very, very curious about allegations that bidding for TV and video production contracts is fixed. 

It's difficult to predict what the result of the investigation could be this time around.

Richard Robinson, managing partner of London-based marketing consultancy firm Oystercatchers, said: "In my experience, legal people think in a very binary context: Did the agency do a rigorous job of finding their client the best value for money or did they have a predetermined objective of doing the job themselves? Has anyone involved broken the law and, if so, was it pre-meditated or was it by accident, unintentional or just unknown when they did it? Can [the DoJ] prosecute? That's up to how angry they decide they're going to get and how much ball the agencies play with the prosecutor."

Robinson points out that clients should also take some of the responsibility here. Did they ask the right questions of their agencies when they briefed or approved the work, and did they even know what the right questions were that they needed to ask? If the investigation does find evidence of bid-rigging, then clients need to ask themselves why it was allowed to happen on their watch.

This could be just the beginning of the DoJ's probe into the ad sector

Sources told Business Insider that this probe could throw the door open for the DoJ to investigate other alleged non-transparent practices in the advertising business.

It is significant that Meiklejohn has subpoenaed K2 as part of her investigation, as first reported by The Wall Street Journal and confirmed by Business Insider with sources with knowledge of the matter.

K2 is an investigations firm that was founded by father-son detective duo Jules and Jeremy Kroll and is staffed by former FBI agents and DoJ attorneys.

The firm also authored the bombshell media transparency report commissioned by the Association of National Advertisers (ANA, which represents brand marketers in the US) and published in June this year.

K2 interviewed 150 sources, of which 117 were directly involved in the media buying business. The resulting report, which did not reveal names of advertising agencies or sources, claimed rebates and other non-transparent business practices were "pervasive" in the US media ad buying ecosystem.

K2 alleged it had uncovered "substantial evidence" of non-transparent activity including agencies taking rebates from media owners and not disclosing them to clients, agencies buying media space ahead of time and selling it back to clients at a higher cost with no added value, and agencies feeling pressure to direct client spend toward media owners in which their holding company has an investment.

The ANA report was condemned by all of the big advertising agency holding groups, which questioned the motives of the report's authors (the suggestion being that K2 stood to win more business the more incendiary the report). Agency groups denied wrongdoing and criticized the methodology, arguing that the anonymous nature of the report caused damage to the reputation of the entire industry by tarring everyone with the same brush.

The Wall Street Journal suggests that K2's subpoena refers to a section of the report about bid rigging related to production agency contracts, which was in the first draft of the report but was removed from the final edit as the ANA wanted it to focus just on the media-buying side of the business.

But sources have suggested to Business Insider that the subpoenas could lead the DoJ to extend its probe into the media-buying landscape too. It's likely some of the people K2 interviewed about production contracts also offered information about how the US media market works. Those interviews could work their way into the hands of Meiklejohn, who can offer whistleblowers protection from prosecution if they agree to cooperate with her.

A spokesman for the DoJ told Business Insider: "As a matter of policy, the U.S. Department of Justice does not confirm or deny whether a matter is under investigation."

K2 declined to comment. The ANA told Business Insider nobody from the trade organization had been contacted or interviewed by the DoJ and it has no connection to the investigation.

Nancy Hill, chief executive of the American Association of Advertising Agencies, said in a statement: "It goes without saying that we require our member agencies and their staffs to follow the letter of the law."

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