May/June 2008

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Legislation to hand the Food and Drug Administration regulatory authority over tobacco continues to loom on the horizon.

By David Wellman

NATO remains opposed to retail provisions of the bill “because of the broad and sweeping regulatory powers over the retail sale of tobacco products.”—Tom Briant, NATO

Proposals to grant regulatory authority over tobacco to the Food and Drug Administration (FDA) continue to circulate in both houses of Congress. But with a number of influential figures, as well as the Bush Administration, opposed to such measures—or at least willing to put them on the back burner until 2009—the likelihood of any finished law passing in 2008 is low.

The House Puffs

“Is it going to pass tomorrow?” says Tom Briant, executive director of the National Association of Tobacco Outlets (NATO). “No. But we remain concerned.” Specifically, he points to a pair of new provisions recently added to the House of Representatives’ version of the legislation, one of which could lead to a complete tobacco ban on a local level.

House Resolution 1108, The Family Smoking Prevention and Control Act, would grant the FDA authority to regulate cigarettes and smokeless tobacco products. In a largely party-line vote (17 Democrats and one Republican), the bill was passed out of the House Subcommittee on Health on March 11, and subsequently approved by the full House Energy and Commerce Committee on April 2. That approval clears the legislation for a vote on the House floor.

Before getting out of subcommittee, a pair of notable amendments were added to the bill. The first, offered by Nathan Deal (R-GA) requires that any future regulations or expansion of regulations proposed by the FDA must go through the agency’s usual rulemaking process, including a public comment period. The second, proposed by Michael Burgess (R-TX), addresses funding for the regulations. Under the proposed legislation, the tobacco industry would be assessed user fees that would be used to fund the FDA’s administration of its regulations. The Burgess amendment makes those fees the sole source of funding for tobacco regulation and prohibits any other funds from being used to make up any shortfall. Those fees have been projected to total roughly $5 billion over the next 10 years.

Further changes were made by the full House Energy and Commerce Committee. These included directives that the FDA:

• enforce the retail sales regulations on Indian Tribes;

• issue regulations within 18 months of the legislation being enacted to require age verification for sales of tobacco products that do not occur face-to-face, such as over the Internet or via mail order;

• issue regulations within 24 months of the legislation being enacted to protect minors from the promotion and marketing of tobacco products that are sold through means other than a face-to-face transaction;

• consider steps taken by a retailer to prevent tobacco sales to minors when determining whether to modify or terminate a “no-tobacco sale order,” and;

• consider any penalties or fines a retailer paid to a state in determining the amount of a federal penalty for the same violation.

A vote on H.R. 1108 by the full House is not expected before mid-May at the earliest. The bill has 221 co-sponsors and is expected to pass.

Industry reaction to the legislation was muted. Tobacco manufacturers generally declined to comment; only Lorillard issued an official statement, saying that while it “fully supports reasonable federal regulation of the tobacco industry, the FDA already is overworked by Congress and is the wrong agency for the job.” Lorillard complained that the bill would provide a competitive advantage to its larger rivals, and make the development and marketing of safer tobacco products impossible, and concluded by noting that FDA Commissioner Dr. Andrew von Eschenbach “has made it abundantly clear that he does not believe FDA should be the agency to regulate tobacco.”

Supporters, on the other hand, crowed over the bill. “The bill will stop illegal sales of tobacco products to children, further restrict marketing, especially to kids, and require more informative package health warnings,” Dr. Ron Davis, president of American Medical Association, said in a statement. “The FDA currently serves a vital role in protecting the health of Americans through the regulation of food and drugs. This bill ensures that the FDA will have the resources necessary to regulate the tobacco industry in addition to its current responsibilities.”

For tobacco retailers, the bill still contains some worrisome provisions, asserts NATO’s Briant. One of these is a ban on color advertising of tobacco products in any retail store that sells such items. “The only ad you could have would be the brand name in black letters on a white background,” he explains. “We believe this violates the first amendment.”

NATO’s other big concern is section 917 of the proposed legislation, which allows federal agencies (other than the FDA), states, counties, and cities to completely ban the sale, distribution, advertising, promotion, possession, and use of tobacco products. While Briant acknowledges that states have always had an implied ability to do that, this would be the first time such a power was explicitly written into law. “We believe only Congress should have that power,” Briant says.

He does credit the House for addressing some of retailers’ concerns with the legislation. For example, the Deal amendment requiring the FDA to follow rulemaking procedures when issuing regulations helps allay fears that the agency would adopt draconian regulations without input from Congress or the public. He also applauds the extension of regulation to “remote” sales, such as over the Internet, which levels the playing field with brick-and-mortar retailers. But in the end, NATO remains opposed to retail provisions of the bill “because of the broad and sweeping regulatory powers over the retail sale of tobacco products.”

The National Association of Convenience Stores (NACS) on the other hand, announced that it is withdrawing its opposition to H.R. 1108. “I have seen it written that we have switched from opposing the bill to supporting it, and that is not the case,” clarifies NACS spokesman Jeff Lenard. “What we have done is to withdraw our opposition.” Why? “Because,” he says, “it became clear that we had a narrow window to effect changes to a bill that was going to pass.”

Given how narrow that window was, Lenard says NACS got the changes it sought. “There are some very significant additions to the bill that we had long championed,” he says. “It’s not perfect, but it’s a lot better than we thought possible.”

Same Smoke, Different Year

While H.R. 1108 is expected to pass the full House shortly, the same cannot be said of S. 625, the Senate’s version of the legislation. S. 625 passed out of committee last July, but has never been brought to a vote on the Senate floor. It lacks the modifications made to the House legislation, and is still opposed by NACS and NATO, among others.

The Senate might vote on its bill this summer, Briant says, but it’s possible it won’t take the legislation up at all this year. “It’s an election year, and Congress wants to get back home and campaign,” he points out. And with the Bush Administration opposed, supporters may decide to wait until after the November elections, which may put a more willing partner in the White House. But in either event, the Senate bill, like its House counterpart, has broad support. Lenard says NACS will push for similar changes to S. 625 as were made to H.R. 1108—and in fact, that was one reason for withdrawing its opposition to the House bill.

“With politics, you have to look long-term,” he says. “We wanted to retain the ability to effect future change.” •

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“I have seen it written that we have switched from opposing the bill to supporting it, and that is not the case. What we have done is to withdraw our opposition.”—Jeff Lenard, NACS

MSA Maneuvering

It's common knowledge in the tobacco retail industry that major manufacturers and 46 state attorneys general solved an intense and costly dispute in 1998 by inking the complex $246 billion Masters Settlement Agreement (MSA). What’s less commonly understood are the issues around “complementary” MSA legislation—allocable share and equity assessment statutes that apply to the non-MSA participating manufacturers (NPMs) who entered the market on the heels of the MSA.

The Back Story

In drafting the MSA, the attorneys general and the states foresaw the possibility that original participating manufacturers (OPMs) would need to raise prices to make their MSA payments. That, in turn, would prompt consumers to turn to lower-price NPM brands, and the resulting market share shift would jeopardize the states’ MSA payments, which are made on a per-pack-sold basis. To guard against that eventuality, the states passed a statute mandating that NPMs pay a sum on par with the required MSA payment into escrow. (The escrow funds would be refundable after 25 years unless the states pursued litigation against them.) However, since some NPMs do business in only a few states, the statute provided for regional manufacturers to receive a refund—called the cap release—of the portion of their escrow payments that would have been allocated to states in which it does not sell.

The MSA Today

As the NPMs’ share of market grew—threatening both the business of OPMs and the tax revenue of MSA states—the states began enacting “allocable share legislation,” a measure that removes this cap release. Today, reportedly all but one MSA state (Missouri) has allocable share legislation or an equivalent measure in place. NPMs in several states have contested these measures, arguing that Big Tobacco, NAAG, and state legislators are effectively teaming up to run NPMs out of business.

In fact, in Freedom Holdings sued New York State, charging an antitrust violation under the Sherman Act. The court issued a temporary injunction against enforcement of the allocable share amendment in New York that is still in effect, but the outcome of the case remains uncertain, says David Dobbins, the lawyer who represented Freedom Holdings in the case.

“We completed the trial over a year ago, but we’re still waiting on a decision,” he says. “If we win this, we should be able to do the same thing in all the other states and the MSA will essentially die.”

Meanwhile, several states who already have allocable share amendments in place have also passed an “equity tax,” a tax-and-credit program that institutes an additional tax on cigarettes and then provides OPMs with a credit against that tax. “It effectively kills NPM sales in the state,” says Everett Gee of S&M brands, who argues that states are now so dependent on MSA revenue that they are essentially legislating share of market to OPMs. “I don’t know how the same legislators who said they were ‘leveling the playing field’ with allocable share amendments can now say, ‘We want to add another $3.50 on top of that.’”

The equity tax proposal in Tennessee passed, but was not signed into law by the governor, Gee reports. “He recognized that it was unconstitutional and a potential threat to the entire MSA scheme.”

Even some OPMs agree that the tax and credit program is unfair. “This type of tax would unfairly increase the payment obligations of Participating Manufacturers, would violate the MSA and the U.S. Constitution, and would jeopardize the MSA, thus placing a state’s finances at risk,” wrote Philip Morris in a statement on the MSA. “‘Tax-and-credit’ type proposals are exceedingly risky propositions for the states and should be rejected.”

Despite these protests, equity taxes have already been passed in Michigan, Utah, Alaska, and Minnesota, and remain a threat in other MSA states, notes Gee. “I’m always concerned about the next shoe to drop with the MSA,” he says. •

A Better Bill?

There were several last-minute changes to H.R. 1108 that make it, if still not desirable, something of a better deal for retailers. A rundown of the alterations, courtesy of the National Association of Convenience Stores:

• The bill directs the FDA to require Internet and tribal sellers to verify the age of their purchasers. It also directs the FDA to regulate the advertising that Internet sellers may utilize.

• The bill requires tobacco stores to comply with the same advertising restrictions as other retailers and allows FDA to make other adult-only facilities (like bars and night clubs) comply with those same restrictions as long as doing so doesn’t violate the First Amendment.

• Included is a directive that the FDA must clarify that there are no restrictions on the types of locations that can sell smoking cessation products as long as those locations verify age.

• The bill allows retailers to specify where they would like notices of violation delivered to ensure that they get into the right hands and retailers have an opportunity to take corrective action. Retailers will be able to have their concerns about an alleged violation heard in person at a facility that is convenient to that retailer. It also requires that FDA provide retailers a notice of violation before conducting any follow-up compliance checks.

• The bill requires that the FDA consider the monetary penalty imposed by the state in mitigating the amount of any federal fine imposed for the same violation.

• In determining whether to impose or modify a no tobacco sale order, the bill requires FDA to take into account if a retailer has a compliance and training program in place. It also imposes lower fines for the first three violations if the retailer has a compliance and training program in place.

• The bill does not make retailers liable for problems with warning labels on packs of cigarettes and smokeless tobacco unless the retailer acts like a manufacturer in controlling the label statements, sells illegal product, or alters the label statements. The bill similarly does not make retailers liable for problems with warning labels on ads unless the retailer alters the warnings. •